The Yield Curve Is Flattening ... Just like It Does Every Fed Hiking Cycle

Boston - The media and some market participants can get pretty worked up over the flattening Treasury curve. But the question is: Is it warranted?

It is true that historically a flat Treasury yield curve typically precedes a recession on average by roughly two years. But keep in mind, the yield curve is driven by a range of different factors that has drastically changed over time. The Treasury yield curve is not some soothsayer, with a magical crystal ball that knows the second the Treasury curve inverts, a recession is imminent in two years.

First of all, the 2-year period is an average. Sometimes it has been longer, and sometimes it has been shorter. If a recession is four years out, good luck staying solvent while you wait for that view to play out. Remember, being early is the same thing as being late in investing -- you are wrong in both cases.

Last I checked, the U.S. economy just grew 3.5% in the third quarter and 4.2% in the second quarter, and is on pace for its strongest year of growth since 2004. So why is it that a recession is imminent? I'll admit, I believe growth in the U.S. will start to trail off from these impressive levels, but there is a big difference between growth slowing to somewhere in the mid-2% area, and a recession.

The short end of the Treasury curve has just inverted. This means you now get more yield investing in a 2-year Treasury than a 5-year Treasury. But this shouldn't be a surprise if you do your homework and look at history. As shown in the chart below, the curve always flattens during Federal Reserve hiking cycles.

Blog Image Treasury Yield Spread Dec 5