Yield Curve Remains Near Record Highs
Monday, March 28, 2011 at 11:06AM The slope of the yield curve (the difference between the yield of the 10-Year Treasury vs the 3-Month Treasury) is often looked to as an indicator for the future direction of the US economy. When the curve is steep, the environment is conducive for economic growth, and when the curve flattens or turns negative, you can expect the economy to slow down, or even contract.
The chart below shows the change in the yield curve since the start of 2009. At a current level of 336 basis points, the curve is currently near the high end of its recent range. Given the fact that the curve steepened to near record levels during the credit crisis, the current level also ranks in the 95th percentile of all readings going back to 1962.
Some have argued that the yield curve is no longer a reliable indicator because the near record steepness has only been accompanied by a slow and gradual recovery. That argument may certainly have some merit, but we would caution that back in 2006 when the yield curve last inverted, there was also a widespread view that it was no longer relevant due to the fact that the S&P 500 kept rallying. While it took some time back then for the curve to make its presence felt, when it finally did, the economy and the market's cratered. Along those same lines, we would caution that as long as the economy continues to recover and grow, investors ignoring the yield curve should do so at their own peril.
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Reader Comments (2)
Financial terminology is often confusing and makes no sense. The slope of a curve is not a difference. The slope of a curve is a rate of change, in other words, a division problem. The difference between yields is a subtraction problem. So what, exactly is being said in this article? Bespoke is also consistently so vague as to be useless. What, exactly, does "ignore the yield curve at [your] own peril" mean? Does buying stocks constitute ignoring the yield curve? Or does selling stocks constitute ignoring the yield curve? How is this article supposed to be helpful or interesting?
The yield curve doesn't strike me as a leading indicator of a recovery. And that is the crux of the argument. If the yield curve is lagging then it's irrelevant to decision making and the message it bears has likely been already printed in the newspapers. As one can see from the graph above, the yield curve has already been at higher levels between roughly july '09 and may '10, then it dived. Why did it do so ? Well, most likely answer is that the euro credit crisis sapped confidence in the global recovery and investors piled back in long term UST, driving prices up and the yield curve down. Thus, one can also say that the yield curve is now near historical tops because the investors are confident in the economic recovery in the US and, at the same time, the Fed's tactic of flooding the market with cheap money does not bode well for the 10 year UST. Which goes to say that if a major confidence shock were to hit the economy, the yield curve would duly plunge again, like it did in may '10. Put differently, we are here in the presence of a lagging, irrelevant indicator of market sentiment