The United States Treasury yield curve—the difference between short- and long-term yields—has in recent months begun to flatten. While the yield curve is in constant flux, this flattening illustrates that short-term rates are rising faster than long-term rates—and a flattening yield curve is often a precursor of an inverted one, a remarkably accurate predictor of a coming recession.
Yield Curves Flattening
Despite the United States Treasury yield eclipsing 3% for the first time in four years, the yield curve is flattening. Ten-year treasury yields have not been this low since prior to the Great Recession. While the current yield curve has not dropped below zero, it is possible that it very well could.
And, while not a guarantee that a recession is imminent, this drop has been a precursor to the last three recessions; virtually all recessions began six to 24 months prior to a yield curve inversion. In fact, a San Francisco Fed study revealed an inverted yield curve to be a predictor of each of the United States’ nine recessions since 1955. Despite these concerns, the chairman of the Federal Reserve has informed Congress that, for the time being, rates will continue to gradually rise.
Global Growth Slowdown
Global growth has slowed outside of the United States. And it’s not just the United States that is hiking rates; the UK, India, and Australia have each in recent weeks increased rates. With dollar liquidity tightening, Australia, India, and Indonesia are each experiencing flattening yield curves. Indonesia’s central bank boosted rates for the third time in six weeks in efforts to aid its currency—and a flattening and inverting yield curve could likely spell currency risks.
But trade tensions between the United States and China are providing no favors to Indonesia—or other Asian countries. China has tightened lending in its private sector, which may spell slower growth throughout the region. This is particularly true for Asian nations that are close trade partners with China, the world’s largest economy after the United States. This suggests that many Asian countries may not be headed down the same path as European trading partners that, after a slow first half in 2018, have experienced modest rebound.
Will the Flattening Yield Curve Lead to a Recession?
Despite the concern that the flattening curve could be the first sign of a major recession, one investor is more concerned that too many other investors believe too strongly that the current curve flattening will lead to an inversion, and then to a recession. Richard Bernstein, CEO of Bernstein Advisors and former Merrill Lynch chief investment strategist, told CNBC’s Trading Nation that, “We’ve maybe scarred a generation of investors where people are waiting for the inevitable return of 2008. I don’t think anybody has grown wealth by being scared.” But, if historical trends continue, the flattening and potential inversion of the yield curve may very well lead to a recession.