Tuesday, July 17, 2018

Flatter Yield Curve -- Who Cares?

Wall Street Wags are fretting about the "flat yield curve" but fail to mention that such a yield curve has accurately predicted 14 of the last 7 recessions.

First, the yield curve is the difference between interest rates on 2-year Treasury bonds and 10-year Treasury bonds.  Longer term rates are higher than short term rates for several reasons.  The longer term means more things can go wrong, i.e., the borrower's credit will go bad or inflation may worsen.

Second, short term rates are largely driven by the Fed.  Long term rates are largely determined by the supply and demand for long term bonds.  But not always!

Third, for the last 18 months, the Fed has been raising interest rates in the short term.  Since Quantitative Easing began, the Fed began stimulating the economy by buying long term bonds, driving down those rates.  In other words, the Fed has flattened the yield curve, not the economy.

Fourth, virtually all other economic data indicates a strong U.S. economy.

Fifth, fret not!