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A Dramatic Yield Curve Transition From a Steep Front to Back End Flatness

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25 comments on A Dramatic Yield Curve Transition From a Steep Front to Back End Flatness

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Yield Curve data from New York Fed, chart by Mish

On Wednesday, the Fed hiked interest rates for the first time since 2018. 

The lead chart is as of the close yesterday. Yellow highlight are inversion spots.

The hike was 25 basis points BPs (a quarter-point hike) as widely expected. 

Yield Curve Comments 

  • The front end of the curve is as steep as it’s going to get. Every hike will flatten the front end. 
  • The Effective Fed Funds rate rose by a quarter point to about 0.33 percent from 0.08 percent.
  • At one point on Wednesday, the spread between the 5-year and 10-year notes inverted. The 5-10 spread closed at 1 basis point.  
  • The 7-10 spread is inverted by 3 BPs.
  • The 20-30 spread is inverted by 10 BPs.
  • The 5-10 spread is 1 BP.
  • The 3-10 spread is 5 BPs.
  • The 2-10 spread is only 24 BPs
  • The 3-30 spread is only 32 BPs

Inversion means a shorter-term note has a higher yield than a longer-term note.

Economists watch the 2-10 spread as a recession indicator. 

Treasury Yields December 2021 to Date 

Yield Curve data from New York Fed, chart by Mish

This is a very flat curve between 3 and 30 years and is poised to get flatter as the Fed hikes. 

Yield Curve Spreads Since January 2021 

Yield Curve data from New York Fed, chart and calculations by Mish

Chart Notes 

  • Less than a year ago the 2-10 spread was 159 BPs. With only a single hike, the spread collapsed to 24 BPs. 
  • Unless the 10-year bond further sells off (yields rise), another quarter-point hike will flatten if not invert the 2-10 spread.

Fed Stops Hiking When 2-10 Inverts 

History shows the Fed generally stops hiking as soon as the 2-10 spread inverts for longer than a month.

The Fed has hiked up to the point of causing a 2-10 inversion, but then it stops. Greenspan managed an additional hike or two one time. 

You have to go back to the Volcker Fed in 1978 to find a major exception. Powell is no Volcker.

Let those thoughts sink in as you ponder the Fed’s dot plot of rate hike expectations. 

Dot Plot 

Fed Dot Plot of rate hike expectations. Chart from FOMC, annotations by Mish.

The median fed expectation for the end of 2022 is a total of 7 quarter-point hikes in 2022 and 3 or more hikes in 2023. 

Not Gonna Happen!

Heading into the FOMC meeting there was discussion of the Fed steepening the curve via very hawkish balance sheet reduction. 

See Beware of a Very Aggressive Steepening of the Yield Curve by the Fed

I kept an open mind on this but had my doubts. 

My doubts are now resolved. 

Hawkish Fed? No, This Was a Dovish Fed Meeting

Yesterday, I commented Hawkish Fed? No, This Was a Dovish Fed Meeting

The Fed penciled in 7 rate hikes this year and 4 more next year. Who believes this?

What we have is a Punt by the Fed. 

I am quite certain the Fed does not want to upset the stock market or housing. You can see it in the reaction today, albeit from very oversold conditions. 

Economy Far Weaker Than Most Think

This economy is far weaker than most believe. I side with Steph Pomboy on this. 

These Tweets are in reference to Fed Chair Jerome Powel telling everyone multiple times after the meeting how “strong” the economy is. 

Stock Market Crash and Recession Anyway

As concerned as the Fed might be about inflation and an inverted yield curve, they are clearly more concerned about a stock market selloff and causing a recession by QT or hiking.

The Fed can try to tiptoe its way to a soft landing but it will get in no more than three more hikes in my estimation, and more likely only two. 

Most People Have No Idea How Much Stocks are Likely to Crash

I stick with my call Most People Have No Idea How Much Stocks are Likely to Crash QT or not.

Demand destruction from that crash will lead to a recession (if not before). 

Tiptoe Addendum

This post originated at MishTalk.Com.

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25 Comments
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david halte
david halte
3 years ago
It’s curious Mish would evaluate the yield curve. Given the Fed owns a third of public debt, and persists in counterbalancing its balance sheet.
In 2012 the Fed enacted “twist”. They rolled-over maturing 5-year Treasuries into 10-year Notes, this supported lower mortgage rates. During the time economists commented on this inverted yield curve. They failed to recognize it was a product of Fed manipulation.
These twist Notes are currently maturing. The Fed protects housing market 10-year Notes, but they may be flattening the yield curve to prevent investors arbitraging short term lending rates against specific long Treasury yields, until they increase FFR.
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FrankieCarbone
FrankieCarbone
3 years ago
YIKES! When has the yield curve ever stayed inverted for a spell and bad things did not happen? Anyone know? I know it flipped for a transient last year but then bounced back to positive slope. Anyone know how long it has to stay inverted for it to be a reliable indicator? 
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Jack
Jack
3 years ago
I think the question everyone is thinking: if economy was so strong, wouldn’t we want to cool things down – cool the economy and high inflation.
Seems to be a no brainer conclusion.
Only increasing a meager 25 basis points must point to a cooling economy.
Else Fed has less clue than elementary student, or government debt just cannot afford to pay more interest.
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FrankieCarbone
FrankieCarbone
3 years ago
Reply to  Jack
Ohh, I dunno. 25 bp only equates to 75 billion dollars a year on 30T and with this year’s bumper crop at the National Idaho Money Farm I think we have nothing to worry about. 
And with the stink market ready to scream again on end-of-days new (BTD!!) I think all of that personal and corporate debt will be fine too. 
If we’re lucky we’ll get a thermonuclear war, gold will plunge to 300 and the NASDAQ will blow right past 19,000. 
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LawrenceBird
LawrenceBird
3 years ago
Reply to  Jack
Inflation of the late 70s/early 80s (ie, Volker era) was a different beast than what we have today.  People fail to consider that a lot of these supply issues are likely to result in significant deflationary pressure when resolved.  Semiconductors in particular.   Some commodities eg wheat, coffee are up because of drought which spills over into some meats.  Chicken is under pressure because of widespread bird flu culling of flocks.   And did anyone on the street call the (multiple) collapses in the price of oil and ng the past 15  years?
I don’t see a recession coming but would not be shocked if there is a quarter in the 0-1% range – the us economy is not a memestock, the snap back from covid is pretty much complete.  But I also do not see overall growth outside the historical 2-4% range.   
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MPO45
MPO45
3 years ago
“This economy is far weaker than most believe. I side with Steph Pomboy on this. “
I wonder why Walmart is hiring 50,000 people in April then. 
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Dean_70
Dean_70
3 years ago
Reply to  MPO45
People short on money start to turn to budget friendly options before they have no money at all.  Makes sense to me.
Also, Walmart is investing heavily in competing with Amazon. They have done well the last couple years.
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MPO45
MPO45
3 years ago
Reply to  Dean_70
After Covid, it became more readily visible that America has two economies.   There is an economy of working professionals (lawyers, doctor, technology people, etc) that make $200k and above and haven’t missed a beat even during covid for the most part.   Then there is the other economy consisting of everyone else below $100k in salary and this group has struggled but they always struggle anyway.
The real question with the upcoming “recession” predicted here is if the first group will be impacted at all by a “recession” or simply keep hopping along without skipping a beat.   If covid didn’t hurt this group then I don’t know what will except a total collapse.
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Dean_70
Dean_70
3 years ago
Reply to  MPO45
The .25% by Powel yesterday signifies, to me, that he sees the recession around the corner and is already trying to protect against a deflationary spiral as the collapse begins. 
He would rather risk much higher inflation now than severe deflation later. The whole system is based on inflation and increasing asset prices. My guess is that he exasperates the problem and adds to the risk, not offset it.
He will hike until we are on the edge of the recession then quickly reverse back to zero once asset prices begin collapsing. 
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MPO45
MPO45
3 years ago
Reply to  Dean_70
That’s sounds like a well thought out strategy and I thought the Fed was dumb and clueless from the posts on this blog but clearly shows some level of long term planning based on your theory.   Go figure.
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Scooot
Scooot
3 years ago
Reply to  Dean_70
My view is similar. They’ll keep hiking 25bp regularly to show that they’re trying to do something about inflation, knowing that this won’t tackle it all. The main purpose being to help offset the inflationary flak politicians are getting, but also to raise rates to a high enough, or more normal level, so that they could lift them more aggressively at a later date if inflation doesn’t subside. In the meantime they’re still hoping that the inflation is transitory, hence only 25bp, and that a slowdown or recession will deal with it. 
Where I differ with you is that I don’t think they’ll cut below say 2%, even in a recession, unless inflation is back nearer their 2% target.
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LawrenceBird
LawrenceBird
3 years ago
Reply to  MPO45
Do not conflate tech salaries in SV with tech salaries nation wide.   As to the ‘under 100K’ group – perhaps less spending in high end car leases and similar ‘keeping up with appearances’ purchases would leave them more money for important things like rent/mortgage, retirement, college fund, etc.   Having been on a condo board and dealt with owners in arrears the first things we ask of those seeking ‘help’ is –  why do you have an Audi and a Lexus in your parking spots?   Why are boxes left at your door multiple days a week?
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LawrenceBird
LawrenceBird
3 years ago
Reply to  Dean_70
Not for nothing but you can get the same stuff at Walmart that you can at Target, Amazon and other places.   I think it is a false narrative to imply that Walmart only caters to the down trodden.
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FrankieCarbone
FrankieCarbone
3 years ago
Reply to  MPO45
WalMart Jobs? How do I apply? Getting kinda bored with this engineering racket that I’ve been in. Kinda feel like I wasted a graduate degree on designing functional technology when I had always aspired to be a part-time, no benefits WalMart greeter since I was 10. 
Cause’ EVERYONE knows that when WalMart is hiring greeters that the economy is screaming! NASDAQ, 25,000 and beyond! Cause’ EVERYONE knows that the stink market is an accurate indicator of economic health. 
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WarpartySerf
WarpartySerf
3 years ago
“Powell is no Volcker.”     Gee ,  you think ?    Volcker wore a man’s suit .
Now…… Janet Powell is wearing ……  oh. never mind    
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dbannist
dbannist
3 years ago
Mish:
You said “

The Effective Fed Funds rate rose by a quarter point to about 0.33 percent from 0.8 percent”

I’m sure you meant .08.

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Mish
Mish
3 years ago
Reply to  dbannist
corrected – thanks
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ed_retired_actuary
ed_retired_actuary
3 years ago
Mish, 
Your forecast appears to assume that inflation will reduce substantially in spite of a) very negative real interest rates, b) A huge overhang of base money/GDP at more than double historical norms, c) large (but no longer huge) fiscal deficits
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Captain Ahab
Captain Ahab
3 years ago
Reply to  ed_retired_actuary
Far more interesting to me, is what the ‘yield’ curve says about rational investors accepting negative real real rates. What fun Monty Python would have!
I’m a Fed Guv’ner and I’m OK
I sleep all night, I screw you all day
….chorus….
I hack down rates, I eat your lunch
I go to the lavatory
On Wednesdays I suck up to Goldman
And do deals with Madam Yellen
…. chorus…
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Mish
Mish
3 years ago
Reply to  ed_retired_actuary
Year over year will reduce simply by tough comparisons
Month over month will go down in recession and demand destruction from stock market tanking
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Captain Ahab
Captain Ahab
3 years ago
Chicken or egg? We tend (or prefer) to forget that information flows both ways:  Fed <===> Market.
Does the Fed set rates to direct the market, or in response to markets, or both? We like to presume ‘direct’ since it implies the Fed has control, and the ability to affect markets–and thereby save us from gloom and doom. However, actual bond sales in the market also contain critical information about price and volume. I suspect what we are seeing is as much ‘response’ as ‘direct.’
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Tony Bennett
Tony Bennett
3 years ago
An aside.  Federal Reserve yesterday increased interest rate paid on reserves and reverse repos.  Conducting fiscal policy at taxpayer’s expense to benefit big banks (every cent paid on these operations is one less cent remitted to US Treasury to offset deficit).
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KidHorn
KidHorn
3 years ago
Reply to  Tony Bennett
Banks suffer during a market crash, but always end up unscathed in the end. That’s why I own a lot of bank stocks. The last things that will fail outside of the US government is banks.
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amigator
amigator
3 years ago
I think the rate hikes will be transitory 
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FrankieCarbone
FrankieCarbone
3 years ago
Reply to  amigator
When’s the election again? That is, unless the FED wants a Repulsican CONgress instead of a Democrap one. Uniparty: “We’re the same bird, but with two wings”. 
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