With the business media’s yield curve hysteria, you would think that a flat curve leads to utter devastation. This is somewhat true. History has shown than when the long end of the curve is lower than the short end (for fixed income instruments), a recession sometimes ensues.
Yield curve hysteria: don’t buy into the doom and gloom
I am not panicking, and neither should you. The stock market is ignoring the yield curve hysteria and not buying into a recession. Instead, all major markets are within a whisker of all-time highs again. This is rather extraordinary given the major volatility shakedown in February. Looking back, it seems everyone had predicted the markets had hit a top in January. Yet here we are, with five months left on the calendar and new highs being made.
Plus, recessions are part of a natural economic cycle. You may not like them, but there is no reason to fear them – or fear bear markets – despite what the media tells you.
Let’s put the current market activity into some context. We are nearly 10 years removed from a devastating financial crisis that threatened to knock the world markets and economies back into the stone age. Hence, there was (and still is) a rather loose monetary policy, which was vital to re-stimulating risk takers.
The US took the lead on this policy, and the rest of the world followed. Central banks did what was necessary to pull the global economy back from the brink. You may argue against the timing and tactics, but they did the right thing in a crisis.
During the first eight years of recovery (we are in year nine now), there has been plenty of premium spread in the 2/10 year yield. For the most part, the spread has been over 150 bps due to the generous accommodation policy and very little inflation. Now we are seeing a smaller spread and higher inflation – but that’s not a bad thing.
Even though a flat yield curve sometimes leads to recession, history has shown it is not a guarantee.
Incidentally, the 2/10 spread is about 25 bps now, as the long end of the curve remains stubbornly low. This tells us that even as the Fed continues to unwind the balance sheet, there is still enormous demand for US Treasury bonds. Again, that’s not a bad situation to be in!
Pay attention to the markets and not the yield curve hysteria or anything else you can’t control. Remember that the bond market is more efficient than any market out there.