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It has been a while since I looked at the yield curve. The last time was around this time in 2007 as I noted that the yield curve was flat. That was among many cautionary signals that are clear as a bell in hindsight (isn’t everything?).
If you’re wondering when the Fed will move, it is useful to look at the yield curve. This chart from CitiFX, dubbed “the best interest rate chart in the world”, shows the yield curve for the past 25 years by looking at the yield differential between the 5 and 2 year US Treasury yield:
The six major inflection points correspond to major turning points for the economy and the equity markets. The inverted yield curves occurred in:
- 1989: Almost immediately the Fed started an easing cycle (from 9.75% to 3%)
- 2000: Within about 2 months the Fed started on a sharp easing cycle (from 7% to 1%)
- 2006: The Fed dragged its feet, easing in August 2007 (from 6.25% to basically zero)
Then we have three instances where the yield curve was steep:
- 1992: The Fed started tightening in early 1994 (from 3% to 5.75%)
- 2003: The Fed waited until June 2004 to start tightening (from 2% to 6.25%)
- 2010: With the steepest yield curve on the records, the Fed continues to stand aside.
According to the CitiFX report, based on their track record in previous cycles the Fed will key off real estate prices (the largest indication of inflation/deflation in the US economy), the changing yield curve, as well as the unemployment rate.
Another way to look at this is to consider the 5 year US Treasury bond yield relative to the 2 year bond yield (that is the ratio of the two). This also shows a similar picture with the yield curve once again turning down from an extremely accommodative position.
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