Why The Yield Curve is Flattening And What That Spells For 2018
(….it’s not good)
The yield curve is a very important indicator for economic health. . .
It shows us what the bond market expects going forward.
Let me explain. . .
Normally, with healthy economies, the yield curve is sloping upwards.
This means that shorter term bonds and interest rates are lower than longer term interest rates.
For example, a 3-month treasury note will yield less than a 30-year bond. . .
Because longer time horizons give more time for things to change – or go wrong. Think about where you were 30 years ago, if you were even born yet.
A lot has happened since then, right?
That’s why investors demand higher interest to protect themselves for lending money out for such long periods of time.
It makes sense. if you locked up your money for decades in a long-term investment, you’d naturally expect a higher rate of return than if you only committed your cash for a few months.
Historically, upward sloping yield curves correlate with strong economies.
But things may be changing for the U.S. economy, because the yield curve isn’t sloping upwards anymore–
It’s actually flattening.
Why is it flattening? The Fed is raising rates, and bond holder perception is changing.
When the Federal Reserve raises rates, it pushes up short term interest rates.
When bond investors expect lower growth and inflation, it pushes longer term interest rates lower.
Otherwise said, when the see-saw rises on the left and falls on the right – it flattens.
Why does this matter?
Because historically, flattening yield curves have an uncanny ability to predict looming recessions.
And right now, the flattening is very aggressive. . .
We haven’t seen yields between the 10-year bonds and the 2-year bonds this low since the 2008 Great Recession – over a decade ago.
In fact, it’s becoming worrisome to some. . .
Famed bond king Jeff Gundlach of DoubleLine Capital recently sounded the alarm over this event – calling it the “real deal.”
Even Federal Reserve policymakers have started to worry:
“Two Federal Reserve policymakers urged caution in raising interest rates on Friday, saying that the flattening of the yield curve was a signal that the central bank should proceed slowly” – Reuters, December 1
With the stock market at record highs – we proceed with caution that things may not be as rosy as they’d have us believe.
If you ask me, the writing is right there on the wall.
And as with all crashes, many will head to the slaughterhouse, others will make a fortune.
You can guess which side we’ll be on.
Christoph Grizzard, The Fat Cat Investor
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