Yellen Tells Investors Not to Fear the Flattening Yield CurveBy
Federal Reserve Chair Janet Yellen isn’t among those losing sleep over the flattening U.S. yield curve.
By just about every measure the curve is the flattest in a decade after a relentless one-way trade over the past few months, sparking warnings by some investors of an impending economic slowdown. The spread between short- and long-term Treasury yields has dropped below zero ahead of each of the past seven recessions. In her last scheduled press conference as Fed chair, Yellen acknowledged the relationship between inversions and economic slowdowns, but offered some (cliche) advice to traders: “correlation is not causation.”
“The yield curve is likely to be flatter than it’s been in the past,” Yellen said. She pointed to the so-called term premium, which had been positive for almost all of the past 50 years, yet remains stubbornly negative. It’s a component of long-term rates, and the fact that it’s below zero suggests investors can’t see any upcoming risks that would push yields higher.
“When the yield curve has inverted historically, it meant that short-term rates were well above average expected short rates over the longer run,” Yellen said. “Typically that means that monetary policy is restrictive, sometimes quite restrictive.”
But now, “it could more easily invert if the Fed were to even move to a slightly restrictive policy stance.”
Yellen added that market participants aren’t expressing concern about the flattening trend portending an economic decline. They see the odds of a recession as low, she said, “and I’d concur with that judgment.”
Here’s a look at a selection of curve measures to see how far the flattening has gone this year. All of them are near the narrowest in a decade.
- From two years to 10 years: 57 basis points, down from 125
- From two years to 30 years: 95 basis points, down from 187
- From five years to 10 years: 24 basis points, down from 52
- From five years to 30 years: 62 basis points, down from 114
Treasuries rallied after the Fed’s rate decision and Yellen’s remarks, with the yield curve from five to 30 years steepening as shorter-dated securities outperformed. Some traders appeared to unwind flattener positions.
That trend may prove short-lived if Fed officials keep raising interest rates even with inflation below their 2 percent target.
“The Fed isn’t particularly concerned with the recent reduction of term premium,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote in a report after Yellen’s press conference. “If one thinks that inflation is the one missing component for a curve steepener, the balance of 2017 is unlikely to offer any opportunities to test that hypothesis.”