Flattening of the yield curve
A yield curve tracks the yields of Treasury securities maturing at different times. For example, the yields of two-year securities (SHY) are usually 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.
On September 6, the New York Fed president, John Williams, said that a possible yield inversion should not be a deciding factor for the Fed in determining the rate hikes. He suggested that it should be studied carefully.
The Fed and yield curve
The narrowing of the spread implies that investors are worried that future short-term rates will be lower than they currently are, which could imply 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 seems ready to hike the short-term rates by another 25 basis points in September, there is a high likelihood that the yield curve might become inverted. A more hawkish Fed would lead to exacerbating the market fears rather than assuage them.
Inversion of the yield curve and a possible recession
Whether the inverted yield curve remains a reliable predictor of recession is debatable. However, as more investors and market participants start worrying about the possible inversion and an economic slowdown, the loop strengthens and becomes a self-fulfilling prophecy.
It’s almost a consensus now that there may be little, if any, upside left in the markets. So, gold (GLD)(SGOL) and other precious metals could help mitigate the risks and uncertainty in the event of a major slowdown.