The Global Markets Weekly – 11/17/17

Posted November 18, 2017 by rvillareal

Trouble with the Curve

The shape of the Treasury yield curve can tell us a lot, but not always clearly. Economists offer a number of explanations for movements, and they tend not to be mutually exclusive. An inverted curve is a hallmark harbinger of recession, but the timing it isn’t foolproof. The 2s10s curve inverted about two years prior to the 2008 recession, a year ahead of the 2001 recession, and over a year and half ahead of the early 1990s experience. That’s apart from acknowledging that flattening and low levels can persist for years ahead of any inversion, or recession, and can coincide with surging stock markets.

Narrow interpretations that treat the shape as a representation of the expected path of the funds rate are incomplete. Once we add market realities including the supply and demand of securities across major market segments, pin-the-tail-on-the-donkey estimates of inflation or term premia, a 30yr secular bull market, and the (paltry) global menu of safe asset yields, there’s a little something for everyone.

Given observable trends and DE’s assessment of likely policy action, we’d subscribe to more benign interpretations of benchmark 2s10s curve flattening that’s gotten more play in recent weeks. While it needs to be monitored, motion is typical of a Fed tightening cycle, still-moderate inflation pressures, and downward pressure on the long end given the low level of foreign developed market yields. With short yields off the zero bound, shorter-term curves (yellow line below) are freer to invert, and may be a better place to look than the longer term for a guide on economic developments and the balance of risks.

Coming Week’s Key Indicators and Events:

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