Published: Sat, December 08, 2018
Markets | By Jeffery Armstrong

Treasury yields continue slide with traders wary of 'curve inversion'

Treasury yields continue slide with traders wary of 'curve inversion'

The yield on the five-year Treasury dropped below the two-year and three-year Treasury yields on Monday.

The dollar edged lower on Tuesday as U.S. Treasury yields fell, feeding fears that the Federal Reserve could pause in its rate-hike cycle, while an inversion in part of the yield curve was taken as a red flag for a potential recession.

Generally, short-term bonds carry lower yields because the investment is considered less risky, whereas longer-dated funds have higher yields to reflect the view that an investor's money is at more risk as you commit for more time. A recession isn't destiny, in other words: The Fed could respond to the yield curve's signal by cutting rates to head off the recession.

Benchmark 10-year notes gained 7/32 in price to yield 2.988 percent, after getting as low as 2.986 percent, the lowest since September 18.

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And, even if the latest kink in the yield curve is indeed the first signal of a downturn as many suspect, it does not indicate when it will actually begin nor how severe it will be.

That message, of a Fed committed to a strategy that would not be shaped by short-term data, was echoed this week by Fed vice chair Randal Quarles.

Instead of just reflecting investors losing faith, Fed officials have argued that the recently narrowing gap between short- and long-term Treasury bonds could reflect long-term shifts in global capital flows, or the fact that all interest rates are lower and more compressed together than they used to be.

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The recent weakness in the dollar comes against the backdrop of a temporary truce in the U.S.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either.

According to the San Francisco Fed, each of the nine USA recessions that have occurred since 1955 came between six months and 24 months after a an inversion in the yield curve of two-year and 10-year Treasury yields. "Keep it simple. Quantitative Tightening is bad for stocks".

The yield curve inverted between the 2- and 10-year yield before the recessions of 1981, 1991, 2000 and 2008.

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Whatever the situation with the Fed and the USA markets, emerging markets may be effected even more than the US economy. But it also has not inverted, and a 10-year Treasury yields 0.50 percentage points more than a three-month Treasury bill. However, when investors expect interest rates to decline in the future - typically because of a weak economy - they scramble to lock in today's comparatively high interest rates for as long as possible. The interest rate on 5-year treasuries fell slightly below the interest rate on three-year treasuries.

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