Economists look at the US Treasury yield curve as an indication of the health of the economy.
Treasury bonds are considered the safest non-cash asset investors can invest their money in and so serve as the place many economists and strategists look to get the broadest feel for how much investors are demanding for taking risks.
And so to judge the overall health of the economy and the confidence of investors, economists and strategists look at the “slope” of the yield curve.
When the yield curve is steepening, or longer-term yields are rising faster than near-term yields, it typically signals an improving economy as investors believe they can earn better risk-adjusted returns in assets other than Treasuries.
At the other end of the spectrum, a flattening yield curve occurs when short-term rates are increasing faster than long-term rates, suggesting a slowing economy while investors re-trench and opt for the relative safety of longer-dated Treasuries as riskier assets face potential losses.
And when enough buying happens on the long end of the yield curve — or selling on the short end — the yield curve can invert, meaning long-term rates fall below short-term rates.
This is often a sign that an economy is headed for a recession.
The previous five recessions were predicted by an inverted yield curve, an currently, the 2-year/10-year spread — or difference between the nominal yield on 2-year Treasuries and 10-year Treasuries — is down to 128 basis points, the tightest its been in over six years.
And with the Fed presumed to be ready to embark on a rate hiking cycle, many economists believe the long end of the yield curve will hold steady or drift lower while the front end rises.
This would produce further flattening of the yield curve and potentially an inversion.
A basic use of technical analysis shows a double top has formed over the past six years or so and suggests the yield curve could flatten to -9 basis points, or -0.09%.
And if history is any guide, this would seem to set up the next recession.