Daily Spotlight: Inverted Slope Expected to Revert to Normal

Summary

The yield curve has been inverted for more than a year. But over the past few months, the inversion isn’t so steep. That has important implications for the economic outlook. Back in April 2023, yields on the 2-year Treasury note were about 100 basis points above 10-year yields. Now that gap is 33 basis points. There are a couple of reasons for this change and, in our view, point toward an upcoming shift toward a normal upward-sloping curve in the next few quarters. First of all, U.S. economic trends have been positive. Fixed-income investors have moved away from fears of deflation and are once again seeking a premium in yields versus inflation. That has lifted rates across the yield curve. Second, the Federal Reserve finally is in front of the inflation curve. The central bank is now building a cushion, or a gap, between fed funds and core PCE in order to push inflation back toward 2.0%. That is all well and good — but if the Fed’s gap is too wide for too long, the central bank risks tipping the economy into a recession (which is presumably what the inverted yield curve is signaling). Fed Chairman Jerome Powell has explained to financial markets that he and his colleagues want to continue fighting stubborn inflation, so they likely will keep short-term rates high for a period of time, which is where the markets are now. But the day will

Source: finance.yahoo.com