What the Shrinking Yield Curve Is Really All About

The bond market is getting a lot of attention, specifically the shrinking gap between short- and long-term yields, which has come as a surprise. The immediate logic, however, behind this development isn't difficult to fathom: short-term yields are getting support from the Federal Reserve's desire to keep increasing interest rates, while long-term yields are falling in response to recent economic data that has been decidedly disappointing.

And the disappointment is not limited to various indicators suggesting inflation is slowing, which the Fed likes to say is transitory. The Bloomberg Economic Surprise Index, an aggregated read, is the weakest it’s been since November, and the Citi Surprise Index is at its lowest level since early 2016.

The curve’s behavior is hardly without precedent. Into and during pretty much every Fed hiking cycle it has flattened, though it tended to flatten in a bear market as short-term yields rose more than long-term yields. The exception was the last hiking cycle from 2004 to 2006, when long-term yields fell and remained in a sideways range for much of the time.