By: Steve Smith
One of the most important pieces of investing advice to follow is to listen and consider theses that might run counter to your own viewpoint. In recent weeks here, I’ve been discussing the possibility that a flattening yield curve could portend a slowing economy, maybe even a recession. This would obviously bring about a bear market in stocks.
Well, a recent article from the Heisenberg report puts forth that the real risk would be a steepening of the yield curve. I hadn’t given that much thought, but this prompted me to consider the fact that governments, especially the U.S. and Japan, are running huge deficits which need to be financed with debt. This will bring a large supply of Treasuries to auction in coming months.
That begs the question: with the Fed raising rates, will investors still be willing to gobble up bonds, especially longer dated at a measly sub 3% yield? Will we ultimately start to see some auctions fail, and be unable to absorb the supply? This, in turn, could lead to an accelerated steepening of the curve.
Here is Heisenberg’s article explaining how steepening could lead to a black swan event.
There’s been a ton of chatter lately about relentless flattening in the curve and what it might or might not portend for the U.S. economy.
Although the 2s10s steepened for three straight sessions to close the week, that was off a decade low of just ~41 bps on Wednesday.
This has become a veritable obsession for pundits, even as analysts have variously attempted to take a more nuanced approach by trying to discern whether a flat or inverted curve necessarily means what it used to or otherwise has the same predictive power it may have had in past cycles.
Here’s what one analyst I spoke to over the weekend had to say:
I think in general this whole discussion about curve inversion as a predictor of recession is incorrect. I mean, there was some connection in the past, but causation has changed. The connection no longer holds. Even in 2007, the curve inverted for different reasons; it didn’t know about the recession, otherwise we would have avoided it.