Flattening of the yield curve
A yield curve tracks the yields of Treasury securities maturing at different times. Usually, the yields of securities with higher durations, such as two-year securities (SHY), are lower than those of ten-year securities (IEF) (TLT). The narrowing of the spreads between these yields is referred to as the “flattening of the yield curve.”
If this spread becomes even larger, and the yields on short-term securities become higher than those on long-term securities, it’s referred to as “yield curve inversion” (BND).
The Treasury yield curve turned negative on March 22, with the ten-year yield falling below the three-month yield for the first time since 2007. This is worrying for markets, as the narrowing of spreads implies that investors are worried that short-term rates could fall, implying an economic slowdown. In the United States (SPY) (VOO), an inverted yield curve (TLT) has often preceded recessions.
While there were many ongoing concerns in the market, the final straw that led to the inversion of the yield curve came in the form of weak Eurozone data (HEDJ) on March 22. The data showed a steep drop in manufacturing activity in Europe (EZU). The preliminary manufacturing activity in the Eurozone fell to 47.7 from 49.4 in February—the lowest level since 2013. The flash purchasing managers’ index for Germany (EWG) was particularly weak. US (DIA) manufacturing activity also fell to its lowest in nearly the last two years.
Investors have now started fearing that prolonged weakness in Europe and China and the ongoing trade tensions between the United States and China could lead to a recession in 2019 or 2020.