Flattening of the yield curve
A yield curve tracks the yields of Treasury securities maturing at different times. For example, the yield of two-year securities (SHY) is usually lower than that of ten-year securities (IEF) (TLT). The narrowing of the difference between these yields is sometimes referred to as the “flattening of the yield curve.” In contrast, shorter-term security yields becoming larger than longer-term security yields is referred to as “yield curve inversion” (BND). Yield curve inversion is a cause for concern for some bond traders and investors, as it has been an indicator of upcoming recessions.
Yesterday, part of the US Treasuries yield curve inverted for the first time since the recession, with the spread between five- and three-year Treasury yields narrowing to -0.01 percentage points. The most-watched spread, that between two- and ten-year Treasury yields, also narrowed, to 14 basis points. This level is the flattest the spread has been since July 2007, which was right before a recession. The spread, important for gauging recession risk, narrowed due to the two-year yield rising and the ten-year yield falling below 3%, a crucial level.
The spread’s narrowing implies that investors are worried that short-term rates could fall, implying an economic slowdown. Fed rate hikes can flatten the curve more, as they increase short-term rates. Markets are therefore concerned that more hikes from the Fed could invert the curve. In the next part, we’ll discuss what could be spooking bond and stock markets (SPY).