Saturday, July 21, 2018

When is a Flattening Yield Curve Inversion Really Significant?

Tim Duy has written an excellent article on the recession significance of a flattening yield curve inversion in which he concludes it is not likely to result in a recession until the Federal Reserve continues hiking rates after the inversion.  I think he is correct.

There has been a lot of alarmist speculation on yield curve inversions signaling recession without a thorough look at history and the differences with the past that a long flattening of the yield curve in a


low interest rate environment has.

Here is a prior yield curve article by Tim Duy.

This blog post by Menzie Chinn highlights flattening yield curves in high income countries and includes a link to a study which has an interactive which allows the reader to look at yield curves over time.

Morningstar had an article which also emphasized looking at the yield curve in relation to Federal Reserve rate hikes.

The Bonddad Blog looked at corporate spreads vs. the flattening treasury curve yields and the  implications.  In June 2017, The Bonddad Blog wrote that two Federal Reserve rate hikes may be sufficient for a yield curve inversion.  The Bonddad Blog also looked at the conundrum of 100 years of spreads.

The yield curve inversion does not cause a recession; it is merely a long term signal in the business cycle, although its actual role in the business cycle is opening debated in economic circles and Jared Bernstein believes it is currently receiving too much attention.

David Glasner had a very detailed look at the the liquidity premium and the yield curve during the 2001-2008 period and he concludes that the Federal Reserve's hand is weaker than in 2004, because
" Nominal GDP has been increasing at a very lackluster annual rate of about 4-4.5% for the past two years. Certainly, further increases in the Fed Funds target would not be warranted if the rate of growth in nominal GDP is any less than 4% or if the yield curve should flatten for some other reason like a decline in interest rates at the longer end of the yield curve."  This  conclusion is consistent with Tim Duy's.

Still it is one thing to look at long term treasury yields declining when GDP is below 4% when, in my opinion, it is more important to look at short term interest rates and spreads in a slow growth economy with low to stagnant wage growth.

7/23/18 Addendum

I forgot to include Stephen Williamson's excellent post on "Don't Fear the Inversion - It's the Short Rate That Kills You".


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