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. Back in April 2023, two-year Treasury Note yields were about 100 basis points (bps) above 10-year yields. Now they are about 10 bps below. There are a few reasons for this change, and they point to an upcoming move toward a steeper upward-sloping curve in the next few quarters. First of all, U.S. economic trends have been positive in recent quarters. Fixed-income investors have moved away from fears of deflation and are now once again seeking a premium in yields versus inflation. That has lifted rates at the long end of the yield curve. Second, the Fed is finally in front of inflation and can afford to lower rates. The central bank has built a wide cushion between fed funds and core PCE in order to push inflation back toward 2.0%. This 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 230-250), the central bank risks tipping the economy into a recession. The Fed is now trying to reduce that gap, without letting
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