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Financial Industry Insights from Advisors Asset Management
On May 12, 2014
Viewpoints from AAM - What is the Yield Curve Telling Us?
It is important to understand the changes in the shape of the yield curve and what it may be forecasting. Prior to the weaker-than-expected first quarter GDP of 0.1%, the spread between the 30-year Treasury yield and 5-year Treasury yield had been narrowing since the multi-year high of 253 basis points (bps) on November 20, 2013. More recently, the spread bottomed at 170 bps on May 2; a level not seen since June 2009 when the spread hit 169 bps. As the fixed income market is forward looking, this flattening of the yield curve may be suggesting a slowdown in the economy. This signal does not necessarily mean investors should be immediately adjusting portfolios to reduce credit risk (selling lower-rated securities to purchase higher-rated securities), but it does raise concerns and the curve should be monitored closely as we continue to receive economic data through the coming quarter.
You have probably also noticed economists are now predicting a GDP recovery in the second quarter as the impact from winter weather will be out of the equation. Revisions to first quarter GDP, upcoming economic data, headlines and comments from the Fed can also impact the shape of the yield curve. On April 9 when the FOMC (Federal Open Market Committee) meeting minutes were released we witnessed an immediate steepening in the curve from 185bps to 191bps. The yield curve also flattened by 8bps on May 2 as a result of renewed Ukraine/Russia tension even after the April jobs data was released earlier in the day. These are two examples of how the shape of the curve can change quickly and how important it is to not overreact, or react too soon, without further confirmation from other economic data.
The chart below is a snapshot of the Treasury yield spread changes since 1999 and quarterly GDP for the same timeframe. The shaded areas are recessions. Notice the recent flattening trend which is represented by the blue line moving in a downward direction.
A flattening yield curve is an important signal and it can be difficult to remain focused on long-term goals when we get conflicting economic data. We suggest keeping an eye on leading economic indicators, housing trends, and also watch corporate earnings growth. For certain, the yield curve remains positively pitched, but watch the shape of the yield curve and the average spread over time. If it continues to flatten and we see a trend of poor economic data, it may be a signal to reduce portfolio credit risk.
CRN: 2014-0509-4197 R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com
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