For the first time in over 10 years the yield curve on Fed-issued 3 and 5-year Treasuries has inverted. The difference in yield between the longer term and short term Treasuries dropped below zero on Monday, which means no financial incentive to take on the increased of longer term debt compared to shorter term debt.
It’s been flattening for some time now but there was still a significant question mark on whether the inversion would actually happen. It’s the first stage of a full inversion, which would be the same thing happening to the yields on 2 and 10-year Treasuries but hugely significant nonetheless.
So why is this so significant and what could it mean for those investing online in equities, bonds and other asset classes? It’s certainly not a positive indicator with the yield curve inverting ahead of each of the last 7 major international recessions. However, that doesn’t mean a recession is now inevitable or will follow immediately. There has historically been a time lag. The spread between 3 and 5-year Treasury yields last dropped below zero in 2005, a full 28 months before the international financial crisis hit. What it means at this stage is that markets expect the Fed to hold or reduce interest rates again around 2022/23, which is relatively probably in the context of a long recent period of economic expansion.
A more significant question for those investing online is why the 3 and 5-year Treasuries yield curve has become the first part to invert. Earlier this year it looked more likely that the inversion would be between 7 and 10-year treasuries. One reason is likely to be the increasing volumes of long term debt the U.S. government has been selling recently. That has led to a new widening of the yield curve between 5 and 30-year Treasuries. Fixed income investors now have to ask themselves if further rate increases over the next months don’t simply mean an increased chance of rates being cut a few years further down the line. And how safe is long term U.S. debt given current levels of spending?