Not Your Dad's Yield-Curve Flattening; Bond World Has Changed

  • Recession followed inversions three times in 30 years: UOB
  • Treasuries offer value given ‘substantial’ negative-rate bonds

The U.S. yield curve has already flattened significantly this year and there could be more to come, but there may be little reason to panic over its implications.

"A flattening yield curve may no longer be an effective recession indicator," market strategists Heng Koon How and Victor Yong at United Overseas Bank Ltd. wrote in a note Wednesday. That’s despite curve flattening and even inversion -- where shorter-term Treasuries yield more than longer-term ones -- sometimes being a precursor to economic downturns in the past.

The link is weaker and less straightforward this time around, because two dynamics have changed, they said. First, a substantial stock of bonds with negative yields -- totaling more than $6 trillion as of July -- has weighed on the longer-end of the Treasury curve, by encouraging investors into U.S. debt thanks to the relative value. Ten-year Treasuries offer almost 2 percentage points more than German equivalents, and more than that versus Japan.

Second, term premiums -- the additional yield investors require to buy longer-term debt instead of rolling over short-term securities -- have been depressed. A decade of quantitative easing by central banks have conditioned investors to anticipate low benchmark policy rates going forward, the UOB strategists wrote.

"While the year-to-date flattening of the U.S. yield curve bears closer scrutiny, it is worth noting that due to various reasons mentioned above, the predictive power" may be reduced this time, the Singapore-based duo wrote.

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