Dr. Brian Jacobsen joins us to put the shape of the yield curve into perspective. Next week, he’ll provide ideas about how to approach the fixed income markets.

 

Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. Dr. Brian Jacobsen joins us today to put the shape of the yield curve into perspective. And next week, he’ll provide ideas about how to approach the fixed income markets. Brian, it’s a pleasure to have you with us as always.

Brian Jacobsen: Thanks for having me back.

Laurie: The shape of the yield curve Brian, in your opinion, what state is it in?

Brian: I think that it is somewhat worryingly low. When we talk about the yield curve, we’re often times talking about the different between the yield on a 10-year Treasury and a 2-year Treasury note. And that difference is pretty narrow right now. It’s approximately under 100 basis points, so 1 basis point is .01 percentage points. So it’s pretty narrow and it seems to be getting narrower. A lot of people are noticing that as the fed has been hiking rates, which really affects what’s called the short end of the yield curve—usually that has its biggest impact for overnight borrowing and lending rates going all the way out to around the 2-year Treasury note. That’s where you see most of the impact from Fed rate hikes. As the Fed has been hiking, that longer end, say 10 to 30 years out, that’s been drifting lower. And that has some people scratching their heads.

Laurie: Brian, let me just jump in for a second. Have we seen or experienced this before?

Brian: Back in 2004 to 2006 a fairly similar thing was happening as the Fed was hiking rates. The long end of the yield curve was moving lower. And at that point, Fed Chair Alan Greenspan referred to it as a “conundrum.” He didn’t quite understand why it was happening. Then Ben Bernanke, who became Chair of the Federal Reserve, he did some research at that point and he referred to one of the main reasons being a “savings glut.” You just had too much savings from countries like China—they were trying to invest that savings in the United States in things like U.S. Treasury securities, mortgage-backed securities, and the like. And so that’s what he attributed that flattening of the yield curve to.

Laurie: And is what we’re experiencing of any concern?

Brian: One of the reasons why this becomes a big issue is that people have noticed, at least historically, when the yield curve gets really flat, that can sometimes point to an economic slowdown. And if you get an inversion of the yield curve, where you get the short-end, say a 2-year yield higher than the long end, say a 10-year yield that can sometimes precede recessions. And so I think some people are really watching this to see how low can it go with this yield curve.

Laurie: Okay, so, let’s talk about what signals today’s yield curve is sending.

Brian: I think the signal the yield curve is sending right now is somewhat complicated—as most things in the markets really are. I think, interestingly, before we recorded this interview, Stanley Fischer who is Vice Chair of the Federal Reserve, delivered a speech where he outlined why he thinks the yield curve may be flattening. His speech was really about why interest rates, globally, are very low—but I think it’s very relevant to what we’re talking about here. And as most economists would, he attributes it to demand factors and supply factors.

Laurie: What can you tell us about the demand-side Brian?

Brian: So the demand for Treasury securities and fixed-income instruments—if you think about what drives people to want to save more—he said maybe part of this is due to demographics and aging population. If life expectancies are increasing, that might require people to save more for a longer retirement.  So that’s one factor. But then he also said that there seems to be an increase in precautionary savings. Even though the global financial crisis was back in 2008 to 2009, it’s still fresh in in a lot of people’s memories. And people have elevated precautionary savings, meaning saving that money for a rainy day in case something happens.

Laurie: And the supply side?

Brian: For governments, it seems like there’s plenty of government debt out there. But really the growth of debt has slowed. So maybe that factors in, in part. Stanley Fischer said for businesses, maybe it’s a lack of investment opportunities—not that there isn’t something you can invest in, but he said something that I thought was really interesting and that was that just the pace of technological changes, maybe it has some businesses hesitant to invest for the long term, to take out long-term loans in order to build a new factory or buy equipment. When you think that there may be technological change, [what businesses invest in today] could be obsolete in a few years—which could be affecting things. And I thought that was a rather nuanced way of looking at it.

Laurie: What’s the Fed’s interpretation of the curve? What do they want to see from the curve?

Brian: I think they really want to see those longer-term yields move higher before they start hiking too quickly.

Laurie: Well, thank you Brian. Let’s wrap up part one of this discussion here and pick up the remainder next week.

Brian: Sounds like an excellent plan.

Laurie: And to our listeners, visit our blog AdvantageVoice® to read a July 26th post from Brian called The Fed’s concern: A flat yield curve, which is where you can take a deeper dive into this topic. For now Brian, thank you.

Brian: Thank you!

Laurie: Until next time, I’m Laurie King. Take care.

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