What does a flattening yield curve mean these days? Perhaps not what it used to.
No doubt, the slope of the yield curve, as measured by the spread between two- and 10-year government bonds, has been flattening since 2014 in both Canada and the United States, and the trend has recently intensified: as we headed into December, the curve sat at its flattest level since the Great Recession.
Fixed Income 101 tells us that this foreshadows slowing economic growth. More worrisome, when the two-year/10-year spread hits zero, or less (yield curve inversion), that's generally considered a slam-dunk for impending recession.
So says the textbook. But we acknowledge that some unusual factors are driving the curve flatter in the post-recession era, and they might not signal slowdown or impending recession:
And yet, against these perhaps-unique factors, the yield curve may still be foreshadowing a slowdown. After all, the era of easy money may be coming to a close. That has negative implications for growth, for both structural and historical reasons.
So while we can see the extenuating circumstances creating a flatter yield curve, we're not quite ready to declare that it's different this time. In fact, we believe that the curve is telling investors to tread carefully and be cautious, in particular, when it comes to risk asset allocation.
This post originally appeared on the BlackRock Blog.
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