While yields at the long end of the US Treasury market have been heading lower all year (the 30-year has fallen from 3.93% to 3.32% and the 10-year has fallen from 2.94% to 2.56%) the middle of the yield curve has been acting entirely differently. The 7-year yield has fallen only slightly by about 20bps to 2.23%, while the 5-year yield is actually 1bps higher at 1.75%. Moreover, since the middle of 2012 5-year yields have risen by 216% and 7-year yields have risen by 146% (chart 1 below). The result has been a substantial flattening in the spread between the long end and the middle of the yield curve (chart 2 below).
One interesting observation here is that this flattening is very similar to the flattening that occurred during the last three Fed tightening cycles that preceded recessions, as chart 2 shows. Indeed, as the Fed tightened from ’86-’89, the spread between the long end and the middle of the curve inverted. As the Fed tightened from ’99-’00 the spread again inverted. As the Fed tightened from ’04-’06 the spread barely inverted, but it did flatten substantially. To be fair, Fed tightening from ’94-’95 was preceded by flattening in this spread, but a recession did not ensue. Today, while we do not have inversion of the middle and long parts of the yield curve the spread flattening has been large, especially when adjusting for the level of interest rates. It could be argued that with short rates pegged at zero, we may never get to complete inversion of the middle and long ends of the curve. In any case, rates in the middle of the curve rising while rates at the long end are falling is noteworthy and we’ll continue to monitor it.