Daily Spotlight: Yield Curve Returns to Normal Slope

Argus

•

Jan 23, 2025

Summary

After almost two years of inversion, the yield curve has returned to its normal upward-sloping shape. This has important implications for bond investors and for the economic outlook. In April 2023, two-year Treasury yields were about 100 basis points (bps) above 10-year yields and, according to the textbooks, signaling an upcoming economic recession. Now they are about 35 bps below. There are a few reasons for this change, and they point toward a steeper upward-sloping curve (and an expanding economy) in the next few quarters. First, U.S. economic trends have been positive in recent months, ranging from the unemployment rate to retail sales. Second, government spending has shifted into a higher-growth gear and the U.S. debt level is rising. Fixed-income investors have moved away from fears of deflation and are now again seeking a term premium for their holdings. Third, the Federal Reserve finally is in front of the inflation curve and can afford to lower short-term rates. The central bank has built a wide cushion, or a gap, between fed funds and core PCE in order to push inflation back toward 2.0%. That is all well and good, but if the Fed's gap is too wide for too long (we think a 150-bps gap is desirable, versus the current gap of 200 bps), the central bank risks tipping the ec