Historically, the shape of the yield curve has served as an indicator of stress in the financial markets.

A flattening yield curve is widely regarded to indicate that the economy is going to slow down in the next 12 to 18 months, while an inverted yield curve (when 10-year interest rates are lower than two-year interest rates) is thought to indicate that a recession is on the horizon. A yield-curve inversion usually occurs when investors come to believe that monetary policy has become so restrictive that it will lead to a recession.

Recently, there has been a lot of discussion about the flattening of the yield curve and whether it is indicating the end of the current bull market.

The yield curve has flattened somewhat during the first half of 2018. Yields for two-year bonds rose 75 basis points (bps), while 30-year bonds rose only 35 bps — not as dramatic as the flattening that occurred in 2017, but still notable.

While the shape of the yield curve can be an important indicator, investors must recognize that it isn't the only indicator worth looking at. For instance, the Federal Reserve recently issued a paper demonstrating that another metric — called the "near-term forward spread" — may be a better indicator to watch, and cast doubt on the connection between an inverted yield curve and a subsequent recession.1

One of the major factors influencing the shape of the yield curve, as well as the general level of both domestic and global rates, is the massive quantitative easing that all major central banks have been undertaking over the last five years or so.

Global central banks have purchased more than $10 trillion worth of intermediate- and longer-dated sovereign debt, which has artificially pulled down and held down the yield on most G7 debt. In many cases, this quantitative easing has pulled down many sovereign yields into never-before-seen negative levels for a prolonged period of time. Even today, the Bank of Japan has pegged the yield on their sovereign bonds near or below zero and the European Central Bank has recently reiterated their commitment to continue their zero-rate policy until at least late summer 2019.

These artificially low global yield levels have had a pronounced influence on U.S. Treasury (sovereign) yields, and we do not believe this dynamic will change anytime soon.

Consequentially, our outlook calls for continued flattening of the yield curve, which could easily become slightly inverted by late 2019. The Federal Reserve will most likely continue to increase short-term interest rates for the next several quarters. We believe short-term interest rates will peak near 3% and, if global interest rates are still near zero, intermediate- and longer-dated U.S. Treasury yields could also be near 3%.

In other words, the inverted yield curve would be more of a function of global supply and demand technicals — more a result of central bank policy than an indication of the future economic outlook.

  • This white paper is the property of BNY Mellon and the information contained herein is confidential. This white paper, either in whole or in part, must not be reproduced or disclosed to others or used for purposes other than that for which it has been supplied without the prior written permission of BNY Mellon. This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. The Bank of New York Mellon, Hong Kong branch is an authorized institution within the meaning of the Banking Ordinance (Cap.155 of the Laws of Hong Kong) and a registered institution (CE No. AIG365) under the Securities and Futures Ordinance (Cap.571 of the Laws of Hong Kong) carrying on Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activities. The Bank of New York Mellon, DIFC Branch (the “Authorised Firm") is communicating these materials on behalf of The Bank of New York Mellon. The Bank of New York Mellon is a wholly owned subsidiary of The Bank of New York Mellon Corporation. This material is intended for Professional Clients only and no other person should act upon it. The Authorised Firm is regulated by the Dubai Financial Services Authority and is located at Dubai International Financial Centre, The Exchange Building 5 North, Level 6, Room 601, P.O. Box 506723, Dubai, UAE. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon London Branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. The Bank of New York Mellon is incorporated with limited liability in the State of New York, USA. Head Office: 225 Liberty Street, New York, NY 10286, USA. In the U.K. a number of the services associated with BNY Mellon Wealth Management's Family Office Services– International are provided through The Bank of New York Mellon, London Branch, 160 Queen Victoria Street, London, EC4V 4LA. The London Branch is registered in England and Wales with FC No. 005522 and #BR000818. Investment management services are offered through BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, 160 Queen Victoria Street, London EC4V 4LA, which is registered in England No. 1118580 and is authorised and regulated by the Financial Conduct Authority. Offshore trust and administration services are through BNY Mellon Trust Company (Cayman) Ltd. This document is issued in the U.K. by The Bank of New York Mellon. In the United States the information provided within this document is for use by professional investors. This material is a financial promotion in the UK and EMEA. This material, and the statements contained herein, are not an offer or solicitation to buy or sell any products (including financial products) or services or to participate in any particular strategy mentioned and should not be construed as such. BNY Mellon Fund Services (Ireland) Limited is regulated by the Central Bank of Ireland BNY Mellon Investment Servicing (International) Limited is regulated by the Central Bank of Ireland. BNY Mellon Wealth Management, Advisory Services, Inc. is registered as a portfolio manager and exempt market dealer in each province of Canada, and is registered as an investment fund manager in Ontario, Quebec, and Newfoundland & Labrador. Its principal regulator is the Ontario Securities Commission and is subject to Canadian and provincial laws. BNY Mellon, National Association is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept responsibility for the accuracy or correctness of any of the statements made or advice expressed herein. BNY Mellon is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept any responsibility for the accuracy or correctness of any of the statements made or advice expressed herein. Trademarks and logos belong to their respective owners. BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation. ©2018 The Bank of New York Mellon Corporation. All rights reserved.