The difference in the yields between short-term and medium-term interest rates is narrowing, and it has many investors asking if this means a recession may be looming. In a recent U.S. News & World Report article, Delegate Advisors President Andy Hart explains what the flattening yield curve means for investors.
In normal markets, yields for longer-duration bonds are generally higher than shorter-duration bonds. When short- and long-term yields move closer together, it's known as a flattening yield curve, the publication explains. If the yields for bonds of different durations narrow to such an extent that the yield curve inverts – meaning short-term yields are greater than long-term yields – a recession often follows.
A flattening yield curve doesn't necessarily mean the yield curve will invert. Hart says the CME Group's federal funds futures contract doesn't show short-term interest rates moving much higher in 2018, even after pricing in two interest rate hikes for the year. Those increases wouldn't be enough for short-term rates to overtake long-term rates in 2018, assuming long-term rates stay the same.
Hart also notes that current economic and monetary conditions may prevent an inverted yield curve, at least for 2018.
“The yield curve has flattened over the past two years since the Federal Reserve ended quantitative easing, the monetary policy that kept interest rates ultra-low, and began slowly raising interest rates,” says Hart. “Because the Fed only controls short-term interest rates, its monetary policy affects the short end of the yield curve more than the long end. Although the Fed's actions can trickle up the yield curve, other conditions can influence longer-dated maturities.”