Yield Curve to Completely Flatten in 2018: But How?

Mish

The T. Rowe Price Group expects the yield curve to completely flatten in 2018. This is not a surprise as I have been commenting the same way for quite some time. The more important question is how? By yields converging up, down, or a mix?

Please consider Bond Traders Should Prepare for Yield Curve to Zero Out in 2018.

Just how much further can the relentless flattening of the U.S. yield curve go? All the way to zero, according to T. Rowe Price Group.

“The peak yield on the 10-year Treasury should roughly approximate where the final level of fed funds settles out, so that to us implies a flat yield curve if we assume the Fed will do two or three hikes in 2018,” Mark Vaselkiv, chief investment officer of fixed income at T. Rowe Price, said at a press briefing. In his eyes, the Fed will likely stay the course, and the difference between short- and long-term debt could reach zero as soon as the second half of next year.

Expectations are beginning to build for the Fed to step up its pace of rate hikes as inflation shows signs of stabilizing and with the lowest unemployment rate since 2000. Economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co. are among those forecasting that the Federal Open Market Committee next year will likely tighten four times, rather than the three implied in policy makers’ projections.

Hike Four Times?

If the Fed manages to hike four times, I believe we will see a strongly inverted curve. A few charts will help explain.

US Treasury Yields 3-Months to 30-Years Monthly Chart

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30-year and 10-year yields have been falling as the Fed has been hiking.

US Treasury Yields 3-Months to 5-Years Weekly Chart

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5-Year yields have been flat for over a year. Everything shorter has been rising, everything longer has been falling as shown in the above chart.

US Treasury Yields 3-Months to 5-Years Monthly Chart

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This economy is nowhere near as strong as most believe.

Thursday's industrial production report looked good, but even the Fed admitted that most of it was hurricane related.

For details, please see Industrial Production Jumps: Another Hurricane Effect?

It will not take 4 hikes to the yield curve to flatten. Portions of the curve could invert in December with no hikes at all in 2018.

While others see price inflation picking up, I see price deflation once the equity and junk bond bubbles burst.

I am sticking with my prognosis that a new low in yield is coming on the 30-year long bond.

Mike "Mish" Shedlock

Comments (13)
No. 1-13
NormGriffin
NormGriffin

Hi Mish, what is the best strategy to take advantage of this flattening? Buy the 30 year and sell it when the yield levels out lower or? Thank you for your blog..

JonSellers
JonSellers

If the equity bubble pops, I'd expect an immediate rush into the 30 year for safety perhaps marking a 500 year top. Then the bond bubble would pop as speculators start moving into the now lower priced equities.

Snow_Dog
Snow_Dog

Junk bonds will bust before any of the real damage takes hold in the equity markets. Are you willing to lend to subprime borrowers when rates are on the way up?

Stuki
Stuki

@Snow_Dog:
The theory behind the global yield compression that has, in Europe, led all the way to negative rates for subprime borrowers; is that there no longer are any significant difference between prime and subprime. As long as the central banks keep propping things up come what may, all borrowers and lenders are good. And as soon as the central banks no longer do, they are all bust. Hence, there is, in practice, no meaningful difference in risk. Everything is perfectly correlated. So, no justification for a difference in yield. Which is then taken to mean, that central banks will never have the balls, to let even the shoddiest loan shark go bust, for fear of their favorite hobgoblins: Global contagion and “the system will collapse.” So they’ll keep propping everyone up forever. Or at least until either people grow up, or the Muzzies come and put an end to the idiocy once and for all.

wootendw
wootendw

"I am sticking with my prognosis that a new low in yield is coming on the 30-year long bond." The benchmark low was on July 29, 2016 @ 2.18% according to Yahoo finance historical data: https://finance.yahoo.com/quote/%5ETYX

Ambrose_Bierce
Ambrose_Bierce

Even if we have zero interest rates the problem becomes access to credit. As long as the GOP continues its temporary amnesia about smaller government and fiscal restraint, as well as trading with Communist authoritarian nations, we will be stuck in the quagmire (swamp). Trump is another Deep State shill. When will it change?

Mike Mish Shedlock
Mike Mish Shedlock

Editor

Hi Norm, there is a risk of buying the 30-year. But that is where Lacy Hunt at Hoisington is and has been for years. He has continually been right, among the few. I side with him. But if yields start plunging, I suspect gold will be a bigger beneficiary.

Roadrunner12
Roadrunner12

From an economic neophyte, my understanding is that an inverted curve is a leading indicator that a recession is roughly 12 months away. If the fed did hike a quarter point 4 times in 2018, an inverted curve would definitely be the likely result. I'm having a hard time understanding why they would and even more so as to why they would even lead expectations in that direction.

Realist
Realist

“This economy is nowhere near as strong as most believe.” The economy would be stronger if only there were enough skilled workers to fill all the empty jobs. Fiscal or monetary stimulus won’t help much as long as the shortage of skilled workers persists. As a result of this shortage I continue to expect 1-2% growth for the foreseeable future. The US could probably get 3% growth otherwise.

Maximus_Minimus
Maximus_Minimus

The yield curve flattens because of the prospect of 100 year bond, whose yield should be astronomic, yet isn't. Next question, what's the meaning of stats in a truly artificial, central bank manipulated market, and a too-big-to-fail regime?

Blacklisted
Blacklisted

No matter how much we hate deficit spending and the total debt situation, there is no other place for the BIG money to park. Nobody else has a single currency with a single federal debt, that doesn't need permission from the govt to use, like the Japanese yen. Besides, much of the periphery has a much worse debt problem than the USA.

Our turn will come, but only after the periphery implodes from a higher dollar and and higher interest rates (risk). As the sovereign defaults ripple across the globe over the next couple of years, where else can the quadrillions park? With govt's and pensions defaulting all over the place, who is going to want to hold 30-yr paper, or even 10-yr govt bonds?

Blue chip stocks, gold, silver, and yes, Bitcoin/Ethereum, and anything else that investors believe will preserve their capital, will rise, as the curtain is pulled back on the "full faith and credit" of govt debt. The price of paintings can only go so high. Out of all of the options, stocks are the only market big enough to absorb the BIG flows, that actually is backed by real collateral (plant, property, equipment , and IP).

As the dollar rises from the collapse of balance sheets in the periphery, there could be a pull back in some assets, like commodities that typically move in the opposite direction of the dollar; and the traditional safe-haven of treasuries will likely get a head fake bid, until people figure out the US is also f*cked when exports collapse and civil unrest breaks out from pensions vaporizing like Ethereum ethos. A test will come when the dollar continues to rise even when the yield (risk) on European govt debt rises.

A transition to a new digital global currency will material in the next 5 yrs, which every countries currency will float against; and the financial capital will officially move east in 15 yrs, once China develops its bond market and establishes the rule of law, which they fully appreciate and understand. Unlike the US, China actually has leaders with practical experience, especially in global capital markets that understand what causes capital to flow around the world. The world is changing from our daddy's world, where real men preferred bonds. Nobody alive will have the experience to navigate what lies ahead, especially if one relies on traditional fundamental and technical analysis. Even the geniuses behind the Black Scholes model failed, because their data did not go back far enough.

Blacklisted
Blacklisted

Realistic, get real. The problem is NOT the availability of skilled workers or the access to capital. The problem is CONFIDENCE, which is related to the debt and unequal enforcement of the rule of law. Who in their right mind would start a legitimate business that has to compete with corrupt corps that are connected at the hip with govt? Actually, the root problem is the career politician, which is why job one must be short term limits. If congress attached term limits to any bill, the people would support it, which is the exact reason it will never even be whispered on the Hill.

Realist
Realist

Hey Blacklisted. I agree with much of what you say, including “The world is changing...”. I’m just trying to point out a significant constraint to growth, particularly in the US. It won’t matter much if taxes get cut, interest rates stay low, and all measures of CONFIDENCE go through the roof. There is a shortage of skilled labour in the US (particularly trades and STEM) that will prevent existing businesses from expanding significantly within the US.


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