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Flattening Yield Curve Signals Recession Risk
PHOTO: ISTOCKPHOTO
Wall Street is worried that a flattening yield curve is close to predicting a recession.
Last week, the gap between two- and 10-year Treasury notes was 0.34 percentage points. “It was last at these levels in 2007 when the United States economy was heading into what was arguably the worst recession in almost 80 years,” writes The New York Times.
Growth and earnings are currently strong, but low yields on 10-year U.S. debt suggest the market sees weakness ahead. Flat yield curves have reliably augured recessions.
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My Barron’scolleague Ed Lin gathered advice from experts last week on how to play the flattening curve. He found there’s plenty of opportunity even in this darkening scenario.
Why is the yield curve flattening? Yields on short-term paper are rising as the Federal Reserve raises interest rates. Meanwhile, longer-term rates have been subdued. One factor: Foreign investors, who may even be seeing negative yields in their own countries’ debt, are thrilled to get even a small amount of yield. That means higher interest rates aren’t need to attract buyers.
Another factor concerns inflation expectations. Bond buyers don’t see strong inflation in the longer term, and as a result they aren’t demanding higher interest to protect their spending power. Low inflation sounds good, but rising inflation usually accompanies strong economic growth, and the market is saying it expects long-term weakness.
–Steve Garmhausen
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