Flattening of the yield curve
A yield curve tracks the yields of Treasury securities maturing at different times. For example, usually, the yields of two-year securities (SHY) are lower than those of ten-year securities (IEF) (TLT). The narrowing of the difference between yields is usually referred to as the “flattening of the yield curve.”
When the yield curve (BND) inverts, it means that the yields of shorter-duration securities become larger than those of longer-term securities. The inversion of the yield curve has been a good indicator of upcoming recessions in the past.
After the Federal Reserve chair’s speech at the Fed Symposium, the yield flattened to almost 20 basis points, which is an 11-year low. The narrowing of the spread implies that investors are worried that future short-term rates will be lower than they currently are and are thus implying a possible economic slowdown.
The yield curve mainly reflects bond market investors’ expectations of the Fed’s actions and future economic conditions. The current shape of the curve implies that the bond market expects a weaker outlook for 2019 accompanied by lower inflation.
As the Fed is quite ready to hike the short-term rates by another 25 basis points in September, there is a high likelihood that the yield curve might get inverted.
The significance of the yield curve
As per the minutes from the Fed meeting held on July 31 and August 1, some Fed officials argued that in the United States (DIA) (VOO), an inverted yield curve has often preceded recessions. Therefore, policymakers should consider the slope of the yield curve while assessing economic and policy outlooks.
Others suggested that a number of global factors, such as central banks’ asset purchase programs, may have led to the compression in term premiums. As such, they think that the significance of an inverted yield curve may have declined compared to historical records.
Inversion of yield curve and possible recession
Whether the inverted yield curve remains a reliable predictor of recession is debatable, but as more and more investors and market participants start worrying about the possible inversion and thus an economic slowdown, the loop keeps getting stronger and becomes a self-fulfilling prophecy. Moreover, it’s almost a consensus now that there may be little, if any, upside left in the markets. Thus, gold (GLD) (SGOL) and other precious metals could help mitigate the risks and uncertainty in the event of a major slowdown.