The yield curve’s return to its flattest levels in a decade are drawing investors back to a well-trodden debate in the bond market.
While some still see the yield curve’s flatness as a sign of slowing growth, Torsten Slok of Deutsche Bank and others have dismissed its usefulness as an economic signal. The latter’s view comes after the last two weeks of trade fears and geopolitical jitters in the eurozone drove volatility in the long end of the bond market, pushing down long yields, and flattening the curve even as the U.S. economic outlook remains healthy.
“The U.S. yield curve is not helpful as an indicator of recessions because U.S. rates are moved around not only by U.S. fundamentals but also by many other things, including pension demand and safe-haven demand,” said Slok, chief international economist for Deutsche Bank.
The ups and downs of the 10-year note coincided with the steepening, and subsequent flattening, of the yield curve. The spread between the 2-year yield TMUBMUSD02Y, +3.15% and 10-year yield, a common pairing used to assess the curve’s steepness, widened to 54 basis points on May 17, before narrowing to 41 basis points last Tuesday, its flattest since August 2007, where it has since lingered.
A flat yield curve is usually seen as an indicator that tightening financial conditions are slowing growth. Historically, it’s a mostly accurate recession indicator once the curve is inverted; of course, the timing between an inversion and a recession varies.
See: An inverted yield curve is a recession indicator, but only in the U.S.
Appetite for safe-haven Treasurys amid widespread selling in risk assets has tugged at the yield curve. The yield for the 10-year Treasury note TMUBMUSD10Y, +1.91% climbed to a seven-year intraday high of 3.12% on May 18, but plummeted to 2.75% last Tuesday after Italian turmoil pushed investors to haven assets. That move marked the benchmark bond yield’s biggest one-day drop since Britain voted to leave the European Union.
“These moves were not reflections of investors changing their views on the U.S. economic outlook,” said Slok.
A flattening yield curve could suggest fears of trade conflict and geopolitical seizures in Europe were crimping the U.S.’s growth prospects, but other signals underscore a belief that economic momentum remains strong.
The Atlanta Fed’s GDPNow indicator shows second-quarter growth is on track to hit 4.8%. The Atlanta Fed’s model takes newly released data to project growth and does not necessarily reflect where GDP is likely to end up.
Friday’s employment report painted a positive picture for near-term growth. Some economists said the greater-than-expected bump up in average hourly earnings could be a sign that tight labor markets are finally yielding the missing ingredient for an upsurge in inflation: wage growth.
Read: The ‘real’ unemployment rate reached a 17-year low. Here’s why that’s a big deal.
Slok believes that investors who claim that the struggles of the 10-year note yield to maintain its foothold on 3% is proof that the bond market is bearish on future growth have it all wrong.
“The risks of overheating and inflation are much higher than the risks of a recession. And the irony of this discussion is that the low level of long rates, and hence, the flatness of the curve, is increasing the probability of overheating even further,” he said.
Lower long-dated yields keep financial conditions loose, heightening the risk of an upsurge in growth, not a slump, he said.