Flat Economic Yield Curve Impact to the Economy

The U.S. Treasury yield curve is intensifying concern as it has been moving flat at a quicker rate which could affect the outlook for the economy. Although, this is already expected since the slope of the curve has been a relevant tool because of its stability and positive track record. Oppositely, a narrow curve would mean a slowdown in growth.

The economic signal has been more robust when there is an outright curve inversion, which happens when short-term yields are greater than those on longer-dated Treasuries. It is not the current situation but generally, people aim for 63 basis points. The difference between two- and 10-year Treasury yields have been reduced from 128 basis points in January which is the least gap since 2007 just before the recession began.

There are investors who believe that the Treasury yield curve is enough to guarantee a change in the economic outlook but it is still far ahead. It is necessary to stabilize the changes in the yield curve of the financial market compared to the general economic yield curve.

The spread between the federal funds rate and the nominal gross domestic product is the yield curve of the economy. This association is significant as it determined the ability of businesses and their consumers to afford higher borrowing costs which would ultimately affect the growth of the economy.

Based on third-quarter data,  the economy’s yield curve is near 300 basis points, which is can be achieved by taking the 4.1 percent annualized rate of growth in nominal GDP and deduct to the quarterly average of the federal funds rate of 1.15 percent. The spread widened by 65 basis points compared last year. However, despite the increase of 25 basis points by the Federal Reserve, the gap would increase the estimated by 4.5 percent to 5 percent growth in the nominal GDP which is already anticipated.

Nevertheless, changes in the yield curve of the economy will be supported by the higher spread between the federal funds rate and nominal GDP growth amid a not-so-strong and restricted growth of the financial market. This would prop up profits and equities of businesses. The future perspective of the fixed-income market may not be that positive since higher growth would induce Fed to normalize monetary policy through rate hikes.