The Yield Curve Is Flattening
The Business Cycle
Economies follow business cycles. So, do the stock markets. Since 2009, the Fed’s zero interest rate policy and bond-buying program have been effective in expanding the U.S. economy. However, following the volatility blow up in February, we are hearing more and more about vulnerabilities of the U.S. economy. We’re starting to see economic indicators hinting towards the economy peaking so we want to take inventory of what we know and what we’re focusing on.
- Inflation: In the U.S., inflation has been largely rising since 2015. Now, while the initial rise in the inflation rate in the U.S. has been welcomed as a sign of broader macroeconomic recovery and growth, it is now gaining increased attention. The past year alone has seen a rise in the CPI from 1.6% in June 2017 to 2.4% as of March 2018.
- Industrial production: Industrial activity also seems to be leveling. Manufacturing growth (as indicated by the manufacturing PMI index) has been rising over the past three years.
- Stock market: Equity market growth is robust. The S&P 500 is up about 70% over the past 5 years; 12.5% over the past year alone.
- Yield curve: The Treasury yield curve is significantly flatter than it used to be two years back.
Rising inflation, flattening industrial production, and stock market growth usually characterize the peak of any economic cycle. This has received increased attention as of late while market participants search for information on what is next.
The Flattening U.S. Treasury Yield Curve
The U.S. Fed’s gradual rate hikes since December 2015 have caused the short-end of the U.S. Treasury yield curve to rise rapidly versus the long-end. The long-end of the yield curve plots the interest rates on long-term Treasury bonds and are more tied to inflation expectations. Since an inverted yield curve spells warning bells for a recession, the current flattening is gaining increased attention.
More recently, we have started to see equities strengthen with a notable lack of volume. We interpret this as a sign that market participants remain in a “wait and see” phase while they look for indicators – economic, yield curve, or price related – that will bring clarity to the macro horizon. Regardless of the direction of the next move, these unknowns lay the ground work for long term trends to develop and strengthen.