Vice President, Macroeconomic Strategist
The Chief Fixed Income Strategist’s Views on the U.S. Yield Curve
In the last 24 hours a portion of the US Treasury curve has inverted, namely the 2s – 5s sector, by a couple of basis points. Most market watchers would not classify the 2s- 5s inversion as the key metric for curve inversion or the economic outlook, preferring to watch the 2s – 10s space as a better barometer of (possible) signs to come. Nevertheless, the inversion has caught the attention of many.
Since early October, the market has undergone a significant repricing of Fed expectations driven in part by its own change in tone, partial collapse in global oil benchmarks - and by extension diminished inflation expectations - as well as increasing concerns over the global economic outlook in 2019. These factors are all playing into a generally flatter curve with 2s – 10s at time of writing around 12 basis points, the lowest this cycle.
The 2s – 10s section of the curve is likely to invert in the coming weeks or months as lower oil prices work their way through the street’s forecasts, CPI estimates for the remainder of 2018 as well as the first-half of 2019 come lower, putting additional pressure on the long end of the curve. Here, importantly, we are watching the Fed’s forecasts for inflation, PCE and Core PCE, at its upcoming December meeting as a key metric for its policy path next year.
Of course, many will point out that most – if not all – recent recessions were preceded by an inversion in the yield curve. And while factually correct, we would note that correlation does not equal causation; moreover there has tended to be a considerable lag between the point of inversion and recession, usually measured in multiple quarters.
The US economy remains very strong with the labour market exceptionally tight and small and medium-sized business not only having difficulty finding workers, but also looking to pass along the higher cost of goods and services to consumers. We believe the current economic cycle will continue well into 2019, possibly beyond, and the notion of an imminent recession is unlikely despite the yield curve’s recent flattening.