Lonsec   ⟩   News & Insights   ⟩   News   ⟩   Yield curve signals danger ahead
Gordon Toy

AuthorGordon Toy

DateApril 29, 2018



Bond yields have been moving higher since the start of 2018, with expectations of future Fed tightening and a gradual rise in inflation prompting investors to reassess long-term interest rates. This week, the US 10-year Treasury yield hit 3.00% for the first time since January 2014, in signs that the market is on the path to normalisation (see chart below).

US 10-year Treasury yield has risen to a four-year high

Source: Lonsec, Bloomberg

But while the 10-year yield has moved higher, shorter-term rates have also risen in line with the Fed’s tightening path, producing a very flat looking yield curve. A steepening yield curve typically means investors expect rising inflation and stronger economic growth. In contrast a flat or, more particularly, an inverted yield curve means short-term inflation expectations have accelerated relative to longer-term inflation expectations.

Inverted yield curves have occurred on only eight occasions since 1958. The US economy has slipped into a recession within two years of an inverted yield curve more than two-thirds of the time. As the chart below shows, today’s yield curve is flatter compared to curves associated with previous periods of Fed tightening, indicating that the Fed is tightening into a more precarious economic situation than it has previously.

Today’s yield curve is flatter compared to previous tightening cycles

Source: Lonsec, US Treasury

The flattening yield curve has been an area of recent focus, though not consensus, at the Fed. The San Francisco Fed contends that an inverted curve continues to be a predictor of recessions, though former Fed chair Janet Yellen among others believes that given abnormally low cash rates, this time it’s different.

Historically, when the spread between the 2-year and 10-year yield has been very low or negative, an economic slowdown has followed. As the chart below shows, a negative spread has proved a reliable indicator of a future downturn in equity markets.

Very low or negative spreads can signal a fall in equities

Source: Lonsec, FRED, Bloomberg

Release ends

IMPORTANT NOTICE: This document is published by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL 421 445 (Lonsec).

Please read the following before making any investment decision about any financial product mentioned in this document.

Warnings: Lonsec reserves the right to withdraw this document at any time and assumes no obligation to update this document after the date of publication. Past performance is not a reliable indicator of future performance. Any express or implied recommendation, rating, or advice presented in this document is a “class service” (as defined in the Financial Advisers Act 2008 (NZ)) or limited to “general advice” (as defined in the Corporations Act (C’th)) and based solely on consideration of data or the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (“financial circumstances”) of any particular person.

Warnings and Disclosure in relation to particular products: If our general advice relates to the acquisition or possible acquisition or disposal or possible disposal of particular classes of assets or financial product(s), before making any decision the reader should obtain and consider more information, including the Investment Statement or Product Disclosure Statement and, where relevant, refer to Lonsec’s full research report for each financial product, including the disclosure notice. The reader must also consider whether it is personally appropriate in light of his or her financial circumstances or should seek further advice on its appropriateness. It is not a “personalised service” (as defined in the Financial Advisers Act 2008 (NZ)) and does not constitute a recommendation to purchase, hold, redeem or sell any financial product(s), and the reader should seek independent financial advice before investing in any financial product. Lonsec may receive a fee from Fund Manager or Product Issuer (s) for reviewing and rating individual financial product(s), using comprehensive and objective criteria. Lonsec may also receive fees from the Fund Manager or Financial Product Issuer (s) for subscribing to investment research content and services provided by Lonsec.

Disclaimer: This document is for the exclusive use of the person to whom it is provided by Lonsec and must not be used or relied upon by any other person. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented in this document, which is drawn from public information not verified by Lonsec. Conclusions, ratings and advice are reasonably held at the time of completion but subject to change without notice. Lonsec assumes no obligation to update this document following publication. Except for any liability which cannot be excluded, Lonsec, its directors, officers, employees and agents disclaim all liability for any error, inaccuracy, misstatement or omission, or any loss suffered through relying on the information.

Copyright © 2018 Lonsec Research Pty Ltd, ABN 11 151 658 561 AFSL 421 445. All rights reserved. Read our Privacy Policy here.

For more information contact:

Gordon Toy
03 9623 6373

Related stories

1 Nov 2018 - The SuperRatings and Lonsec Day of Confrontation 2018 may be over, but the conversation hasn’t finished. Once again, the event has sparked discussion ...

Day of Confrontation 2018: Media highlights

By Gordon Toy Read now

1 Nov 2018 - Congratulations to all of the award winners & finalists from this year’s SuperRatings and Lonsec Fund of the Year Awards Dinner. A full list of the ...

SuperRatings & Lonsec Award Winners Confirmed!

By Casey Brown Read now

15 Oct 2018 - Don’t miss the premier awards night for superannuation and wealth management industries The 16th Annual SuperRatings & Lonsec Fund of the Year ...

Award nominees are in!

By Casey Brown Read now