Yield Curve: The Old Normal

Mid Week Bond Update

Yield Curve: The Old Normal

The shift back to an upward-sloping yield curve doesn't necessarily mean that the threat of recession is no more.

On November 6, the U.S. Treasury yield curve ended its months-long sojourn into inverted territory, regaining the positive slope typically associated with a growing economy. Since that date, the curve has remained upward-sloping in the key segments between 3-month and 10-year, as well as between 2-year and 10-year. 


Now Positive: Three Recent U.S. Treasury Yield Curves

Source: Bloomberg, as of 11/12/19 Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Though this return to form may restore faith to some who doubted the strength of the U.S. economy, the question is how long the curve will maintain its current configuration. And spending several months in inverted territory might yet prove to be a harbinger of recession – as in 2006-2007, when the curve reverted to a positive slope before the 2007-2008 Great Recession.

But more important than the slope are the forces behind it, many of which feel more changeable than in past business cycles -- such as inflation expectations and economic policy decisions. One such factor, however, has continued to trend upward since its low in December 2008; more than 55% of those surveyed by the University of Michigan’s most recent consumer survey said that their financial situation had improved over the previous year. 

On the rise: Reserves in Italy’s Banks 

Italy’s lending institutions took full advantage of the recent decision by the European Central Bank (ECB) to create a two-tier rate regime for what it charges some banks for depositing their excess reserves with the ECB. The charges, in the form of negative interest rates, are designed to encourage lending by making it expensive to keep funds on deposit rather than put them to use lending to their clients. As of the beginning of November, those charges are now waived for banks with reserves below a certain level, many of which are in countries with troubled banking sectors – including Italy.

The result so far has been a multi-billion euro movement of excess liquidity from countries with large liquidity balances such as Belgium, Germany and the Netherlands toward countries that haven’t hit their tier-related ceilings.  The objective has been to reduce the balances on deposit with the ECB – and the associated charges for keeping those deposits. One bank analyst summed it up: “...this is such a convenient arbitrage that it’s a must-do.”

So far, the tiering system seems to be on its way to achieving one of its key goals, to reduce financial pressure on borderline banks. It remains to be seen what unintended consequences might arise as a result.

On the slide: Chile’s Bonds, Currency, and Civil Order

Since the beginning of the protests in Chile in early October, the country’s currency, the Chilean peso, has fallen as much as 10% against the U.S. dollar since October 41. Chile’s 10-year government bond yields have risen some 78 basis points (bps). 

The current crisis started with a student-led protest over subway fares on October 6, and has turned into leaderless general strikes, arson, looting and riots. In that environment, the central bank president Mario Marcel’s assurances that the fiscal situation remains “solid” and that the bank is willing to act in the face of “anomalous situations” ring somewhat hollow. The announcement of plans to change the country’s Constitution, which dates from the 1973-1990’s era dictatorship, have had little effect so far. Copper is the country’s chief source of foreign exchange, and production has continued mostly unhindered so far. But without organized leadership for the protests, the trajectory and duration of the instability is difficult to assess.


Note: The year for all dates is 2019 unless otherwise indicated


1 Source: Bloomberg, as of 11/12/19 3:00 PM, ET



The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

One basis point (bps) equals one one-hundredth (1/100, or 0.01) of one percentage point.



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