Tuesday, March 22, 2022

The US Treasury yield curve is on the verge of inverting


 - by New Deal democrat

My graphing issue hasn’t resolved yet. Fortunately there is no big new economic news today, and there is something I’ve been following with particular interest in the past week that doesn’t require any graphing: namely, the Treasury bond yield curve is on the verge of inverting.

Normally, we should expect to see increasing yields the longer the maturity. This is pretty simple stuff: if I lend you money for a longer period of time before you have to pay it back, I’m taking a bigger risk, so I should get paid more in interest to take that risk. An inverted yield curve means that there are shorter maturities yielding higher interest than longer maturities. It’s well-documented that when the yield curve inverts, especially over a broad range from a few months out to 10 or more years, it is a harbinger of an economic downturn, typically 12 to 24 months later.

As of this morning, here are the yields on US Treasuries from 3 months to 30 year maturities. The curve is inverted at 3 maturities, marked with asterisks:

30 year: 2.570%
20 year: 2.693%*
10 year: 2.337%
7 year: 2.381%*
5 year: 2.360%
3 year: 2.365%*
2 year: 2.170%
1 year: 1.364%
6 month: 0.973%
3 month: 0.563%

I’m not terribly concerned about the 20 year (paying less than the 30 year) or 7 year (paying less than the 10 year) inversions. Neither the 7 nor 20 year bonds are heavily traded. At the moment we’re having a flight to liquidity due to the Ukraine invasion, so the 10 and 30 year bonds have lots of increased buying.

By the way, if you want to see what the yield curve looks like at the moment (since I can’t show you the graph), you can see it at this link.

The 3 to 5 year (and 10 year) inversion will be more concerning - if it sticks. For the past week, the 3 year Treasury has paid more than the 5, or for that matter, 7 or 10 year Treasury multiple times *during* the day, but at the end of the day has always settled at a yield lower than the longer maturities. I am writing this during the morning, so once again there is an intraday inversion.

A 3 to 5 year inversion has historically been one of the earlier maturities to invert, and more often than not, heralds an inversion spreading out along the midrange of the curve. This means, basically, that buyers expect Treasuries to pay more over the next several years than the anticipated long term norm, i.e., the Fed will continue to tighten, credit will be tight, and interest rates will ultimately recede due to slackening consumer demand, typically brought about by higher unemployment and a recession.

We’re not there yet. But stay tuned.