Ask CIO: Is the flattening yield curve a warning sign?


Historically, the shape of the yield curve is a harbinger of recession as it usually inverts before that
Chief Investment Office25 Feb 2019
Photo credit: AFP Photo


In recent conversations with our clients, we received many interesting questions, and will be addressing them in a new series of CIO Perspectives, “Ask CIO”. We hope you find this insightful and enjoyable.

The yield curve, also known as the “term structure of interest rates”, compares interest rates of similar quality bonds over different maturities. It undergoes inversion when long-term yields are lower than short-term yields as a result of:

  • Central banks hiking policy rates aggressively to counter rising inflationary pressure, driving up the yields of shorter-dated bonds in the process; and
  • As a result of aggressive rate hikes, investors expect economic conditions to deteriorate in the long run, leading to yields on the longer end of the curve falling fall or not rising in the same magnitude as yields at the short end.

Historically, the shape of the yield curve serves as a harbinger of recession as it usually undergoes an inversion before that. For instance, an inversion of the US Treasury (UST) 10-year less 2-year yield curve in 2000 preceded the 2001 US recession and crash of the dot-com bubble. Years later, an inversion of the yield curve in 2006 preceded the subsequent Great Recession.

Currently, the yield curve is very flat with the 10-year less 2-year spread at c.16 bps; investors are concerned if another recession is around the corner. We do not think so.

 

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