Explainer: The US yield curve has flattened: why you should care – Natural Self Esteem

The Federal Reserve building is seen on January 26, 2022 in Washington, USA. REUTERS/Joshua Roberts

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NEW YORK, March 17 (Reuters) – The US Treasury yield curve flattened further on Wednesday as the Federal Reserve hiked rates for the first time in three years and charted a path for tighter monetary policy to combat unabated inflation . Continue reading

The shape of the yield curve is a key metric that investors watch because it affects other asset prices, affects bank returns and has been an indicator of how the economy will perform. The latest moves reflect investor concerns about whether the Fed can tighten monetary policy to tame inflation without hurting economic growth.

Here’s a brief introduction explaining what a steep, flat, or inverted yield curve means and whether the current shape of the yield curve predicts a recession.

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WHAT IS THE US TREASURES RETURN CURVE?

The US Treasury Department funds the federal government’s budgetary obligations through the issuance of various forms of debt instruments. The $23 trillion treasury market includes 1-month to 1-year Treasury bills, 2- to 10-year debt securities, and 20- and 30-year bonds.

The yield curve represents the yield on all government bonds.

WHAT SHOULD THE CURVE LOOK LIKE?

Typically, the curve slopes up because investors expect more compensation for taking on the risk that rising inflation reduces the expected returns from owning longer-dated bonds. This means that a 10-year bond will typically pay more than a 2-year bond because it has a longer maturity. Yields move inversely with prices.

A steeper curve typically signals expectations of stronger economic activity, higher inflation and higher interest rates. A flattening curve can mean the opposite: investors are expecting interest rates to rise in the near term and have lost confidence in the economy’s growth prospects.

WHY IS THE YIELD CURVE FLATTENING NOW?

Short-term US Treasury yields have risen rapidly this year, reflecting expectations of a series of rate hikes by the US Federal Reserve, while longer-dated Treasury yields have moved more slowly amid fears that monetary tightening could hurt the economy.

As a result, the shape of the US Treasury yield curve has generally flattened. A closely watched portion of the curve, which measures the spread between 2- and 10-year Treasury bond yields, showed the gap at 24.5 basis points on Wednesday, over 60 points lower than at the end of 2021. That flattening widened on Wednesday thereafter The Fed hiked interest rates.

While interest rate hikes can be a weapon against inflation, they can also slow economic growth by raising the cost of borrowing on everything from mortgages to car loans.

Two-year US Treasury yields, which track near-term interest rate expectations, have risen to 1.94% from 0.73% at the end of last year, an increase of 166%.

Yields on 10-year US benchmarks have risen from 1.5% to around 2.19%, a rise of 46%. In February they exceeded the 2% mark for the first time since 2019.

WHAT DOES AN INVERSE CURVE MEAN AND WILL IT HAPPEN?

Some investors and strategists have forecast that a curve reversal could occur later this year, with short-term yields higher than long-term yields – an ominous sign.

According to a 2018 report by researchers at the Federal Reserve Bank of San Francisco, the US curve has inverted before every recession since 1955, with a recession lasting between six and 24 months. It only gave the wrong signal once during that time.

The last time the yield curve inverted was in 2019. The following year, the United States slipped into a recession – albeit one caused by the global pandemic.

IS THE WHOLE CURVE OR PART OF IT INVERTING?

Traders typically monitor the shape of the curve, which is determined by comparing 2-year and 10-year Treasury bills, as a yield curve inversion at this spread has anticipated previous recessions. This curve is flattening but not yet close to an inversion, with the spread narrowing to 24.5 basis points from 10:10 pm on Wednesday.

However, distortion can appear anywhere along the curve without inverting the entire curve.

On Wednesday, the 5s/10s curve inverted in intraday trading. It returned to positive territory, but the gap had narrowed to 0.4 basis points from 3.8 the previous day.

A less closely watched portion of the curve has inverted several times in recent weeks, with the 10-year Treasury premium versus 7-year Treasuries ending in negative territory every day since March 11th.

The 20-year/30-year spread has been negative since late October, although supply/demand technicals may have contributed.

WHAT DOES THIS MEAN FOR THE REAL WORLD?

Aside from potentially signaling the economy, the shape of the yield curve has implications for consumers and businesses.

When short-term interest rates rise, US banks tend to raise their benchmark interest rates on a wide range of consumer and business loans, including small business loans and credit cards, making it more expensive for consumers to borrow. Mortgage rates are also rising.

As the yield curve steepens, banks can borrow at lower interest rates and lend at higher interest rates. Conversely, when the curve is flatter, their margins are squeezed, which can discourage lending.

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Reporting by Davide Barbuscia Editing by Chris Reese

Our standards: The Thomson Reuters Trust Principles.

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