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The Yield Curve Is Flattening? Don’t Think So
A flattening yield curve may be a thing of the past if Oil has any say. Much has been over the past couple of weeks about the spreads between the 10-year yield minus 2-year yields contracting. In fact, some are evening worry it may forecasting a recession.
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The forces causing the yield curve to two flatten is two-fold: The Fed is the first reason, and a global market that has no yield is the second. The Fed raising rates are causing rates on the short-end of the curve to rise, while international markets offering low yields are causing foreign buyers of bonds to flock to our longer-dated bonds.
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As of the end of September, the spread between US 10-year and the German 10-Year was nearly 2 percent a level not seen since late 1980’s. We can see the spread now stands around 2 percent.
The same effect has taken place versus the Japanese 10-year yield as well.
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Low Inflation
One reason why this has been able to happen is that inflation has been relatively stable. Foreign investors feel comfortable buying US debt, without the fear of the yields falling behind the inflation rate.
The producer price index on a y/y basis has been relatively tame since 2012 and has been pretty much around zero or negative until this past year. We have seen the PPI begin to rise again in recent months.
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Oil
When we look at the price of Oil on y/y percentage change basis, we can see that PPI follows Oil very closely. The charts look nearly identical, and part of the reason for the rise in PPI in 2017, was because Oil had increased so much off the lows in 2016. Now Oil is starting to rise again, and that could push PPI up even higher, perhaps over 5 percent on y/y basis.
Yields To Go Higher
If that should happen, we will see the yield curve begin to widen, and the fears of the flattening yield curve would turn to concerns about runaway inflation, perhaps pushing yields on the US 10-year above 3 percent in 2018.
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The chart below shows how the 10-year has been consolidating sideways over the past year, and has formed a symmetrical triangle. The current pattern is supportive of yields breaking out and heading higher.
Have a great night, and Happy Thanksgiving!
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Tags: #Oil #yields #yield #curve #flattening #spread