Opinion: The Yield Curve Hysteria Is Totally Misplaced

With all the mass hysteria in the business media about the incredibly flattening yield curve, one would think that the consequences of a flat curve would be devastating.  History has shown than when fixed income instruments on the long end of the curve is lower than the short end, a recession usually ensues.  It's not if, but when.  Okay, we get that and history must be heeded and we should be prepared.

Yet, the stock market so far is not buying it.  In fact, we have all markets within a whisker of all time highs again, something rather extraordinary after the major volatility shakedown in February.  It seems everyone had 'predicted' the January flurry was the top for the year.  Well, if I look at the calendar I see there are more than five months remaining - so maybe that was a bit premature.

Recessions are part of a natural economic cycle.  There is nothing to fear or worry about, just like bear markets are nothing to fear.

But let's put this into some context here.  We are nearly 10 years removed from a near 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, something that was vital to re-stimulate risk taking.  

The US took the lead on this and the rest of the world followed. Fact:  Central Banks did what was necessary to pull the world economy back from the bring.  You may argue the timing and the tactics, but they did the right thing in a crisis.  Period.

During the first eight years of recovery (we are in year nine now) there has been plenty of premium in the spread of the 2/10 yr yield.  For the most part, well over 150 bps at most times, due to the generous accommodation and very little inflation to speak of.  All of that has changed now, but it's not a bad thing.

>In fact, history has also shown a recession is not necessarily imminent with a flat yield curve.  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 our treasury bonds.  

That's not a bad thing!  Let's just pay attention to the markets and not they hype/hysteria over things that we cannot understand clearly or control.  The bond market is more efficient than any market out there.

Related Links:

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