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Flattening Yield Curve…

In this weekend update, we look at the Fed and the flattening yield curve.

This past week the continued increase of equities and in the probabilities of a Federal Reserve rate hike has kept volatility low and flattened the yield curve. In looking at the yield curve we can see the small difference between rates. The 2-year yield is at 1.78%. The 5-year yield is at 2.13%. The 7-year yield is at 2.28%. The 10-year yield is at 2.37%. The 20-year yield is at 2.58% and the 30-year yield is at 2.76%.

This means the difference between a 2-year bond and a 30-year bond is only 1% difference. There is very little difference in the various maturities. This small variance gives investors no incentive to invest in long-term bonds versus short-term bonds. The risk premium is not enticing. When the yield curve flattens or worse inverts, investors only invest short term which means businesses small and large have a difficult time raising debt to grow and expand their businesses.

The inverted yield curve has been a predictor of a recession 13 of 15 times it has occurred. It is little wonder the FOMC is concerned about the flattening yield curve. The Fed will likely raise short-term rates in December which will flatten the yield curve further. St. Louis Fed President James Bullard and Dallas Fed President Robert Kaplan both have issued cautious statements and indicated they were wary of increasing rates too quickly.

The parabolic equity moves in equities and the flattening yield curve should be warnings investors should be leery of.


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