Trouble With the Curve?

March 09, 2022 | Evan Frazier, CFA, CAIA, Senior Research Analyst

Two-line chart showing 2/10 Treasury spread and effective federal funds rate since 1999. Chart subtitle: The difference between the 2- and 10-year Treasury yields has narrowed in recent months, and upcoming rate increases by the Federal Reserve could lead to further spread tightening. Chart visual description: Left y-axis shows Basis Points, ranging from -100 to +300. Right Y-axis shows percent range from -3% to +8%. X-axis dates range from 2/28/99 to 2/28/22, with annual increments. Recessions are shaded in light blue, representing the Dot-Com Bubble in 2001, the Global Financial Crisis in 2008, and 2020’s short-lived Coronavirus recession. Slate line represents 2/10 Spread and corresponds to the left Y-axis (basis points). Light purple line represents Effective Federal Funds Rate and corresponds to the right Y-axis (percent). Orange arrows overlaid on the chart indicate 2/10 inversions (when line crosses X-axis) preceding recessions, in 2000, 2006, and 2019. Chart data description: The 2/10 Spread line has come down significantly since the start of 2022 and currently sits at approximately 23 basis points, its lowest since March 2020. In the early 2000s, the line peaked at 270 in 2004 before falling and inverting in January of 2006. It hovered near zero and inverted several times in the years leading up to the Global Financial Crisis, then climbed and fell and climbed to a peak of 291 in February of 2011. Since then, its highest level was 260 at year-end 2013, and it has fallen with a few periods of rising until April 2021’s level of 151 basis points. The Effective Fed Funds Rate has hovered near zero for the last two years. Prior to the Global Financial Crisis there were two major hills of climbs and falls, with the highest point charted in July 2000 at 7%; it fell following the 2001 recession and then rose again until the GFC, peaking at 5% in September 2007. Since then it has remained low; the most recent highs were from March to September of 2019, just over 2%. Source: Federal Reserve Bank of St. Louis as of March 7, 2022.

Short-term interest rates have increased dramatically since the fourth quarter of 2021 amid inflationary pressures and concerns surrounding reduced global market liquidity. The 2-year Treasury yield ended February at 1.33%, up from 0.56% at the end of November 2021, and has continued to rise throughout the first few days of March. The yield on the 10-year Treasury has also ticked up in recent months, albeit at a much slower pace than that of the 2-year instrument. As a result, the spread between the 2- and 10-year Treasury yields has contracted significantly since the beginning of the year and currently sits at approximately 23 basis points, its lowest level since March 2020. Current yield curve dynamics could be exacerbated by the Federal Reserve, which, after holding short-term rates near zero for the last two years, is set to begin a hiking cycle later this month. Increases in the federal funds rate, though likely modest (25–50 basis points per increase), could number as high as seven in 2022 and result in additional yield curve flattening.

The relationships between Treasury yields of different maturities are important considerations for investors and traditionally serve as key indicators of macroeconomic trends. Typically, longer-dated debt instruments have higher yields than short-term bonds due to increased risk and liquidity premiums, resulting in relatively wide spreads and an upward-sloping term structure of interest rates, an indication of solid growth expectations and overall economic health. An inverted yield curve, marked by short-term yields that are higher than long-term yields, is commonly considered a bear signal, as it implies that the nearer term is riskier than the longer term. Each instance of a 2/10 inversion dating back to the 1990s has been followed by a recession in the United States within the next two years.

It is important to note that a narrowing 2/10 spread does not necessarily portend an economic downturn, as most economists expect positive economic growth in 2022 and beyond given solid corporate fundamentals and strong consumer balance sheets. Still, recent sell-offs in equity markets, elevated inflation, and supply shortages stemming from the conflict in Eastern Europe are causes for concern, especially when viewed in tandem with narrowing Treasury spreads. Marquette will continue to monitor the term structure of interest rates, as well as other leading macroeconomic indicators, and advise clients accordingly.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Evan Frazier, CFA, CAIA
Senior Research Analyst

Get to Know Evan

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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