Rate increases can be a weapon against inflation, but they can also slow economic growth by increasing the cost of borrowing for everything from mortgages to car loans. Distortions can occur anywhere along the curve without inverting the entire curve. On Thursday the yield on the year bond rose above the year bond. The phenomenon is not confined to the United States. Short-term rates have climbed in Australia, Germany, Canada and other countries where central banks are projected to tighten monetary policies at a faster-than-expected pace.
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You have not saved any content. The volatility that has roiled short-term bonds signals a shift in expectations for central bank policy in developed markets. Y ields on short-dated notes have moved sharply higher in recent weeks, while those on longer-dated bonds have fallen modestly in many countries. This flattening of yield curves has come in response to worries about inflationary risks potentially being more persistent in the near term and lasting longer than previously anticipated.
The speed and magnitude of this repricing suggest investors expect central banks in developed countries such as the U. Many investors are left wondering what to expect from the next stage of monetary policy. Despite the recent volatility, market pricing still indicates a belief that central banks will act in a credible manner to keep inflation expectations well-anchored. Long-term inflationary expectations have also remained relatively stable. Flattening of yield curves typically occurs relatively later in an economic cycle as investors expect central banks to raise short-term policy rates, which pushes up short-dated yields relative to longer-term ones.
Yield curve behavior can thus foreshadow changes in monetary policy and the economic outlook. Much of the recent change in market thinking relates to questions about the persistence of supply chain disruptions and supply-demand mismatches in various sectors as the global economy emerges from the COVIDdriven slowdown. With some inflation metrics remaining elevated, market participants are envisioning a more imminent reduction in quantitative easing, with interest rate hikes on the horizon.
The recent moves in the front end of interest rate curves have led to a deleveraging of many traditional fixed income relative value and carry-focused strategies globally. This includes hedge funds reducing risk exposure after losses caused by the rise in front-end rates, including buying back their short positions in the long end, furthering the flattening effects. With the rise in volatility and transaction costs, traditional intermediaries and existing market structure have made it difficult for true liquidity providers to support the market and ease these dislocations.
Indeed, the extent of dislocation across yield curves is the greatest since March On one hand, broader curve flattening and shorter economic cycles are consistent with our secular view that economic cycles are likely to become shorter and of greater amplitude than in the past, and may involve a comparatively early withdrawal of monetary accommodation.
Yet in our view, the extent of the recent flattening suggests markets may have shifted too abruptly. Like the markets, many central bank officials have also seemed to change their tune on inflation.
For much of this year, they suggested the accelerating inflation showing up in economic data was transitory. Develop and improve products. List of Partners vendors. Table of Contents Expand.
Table of Contents. The Yield Curve. Flat Yield Curve. How a Curve Flattens. Inverted Yield Curve. Steep Yield Curve. How to Use the Information. He has more than 25 years of experience in the finance industry and is a partner and co-founder at Boston Investor Communications Group, a communications company for mutual fund and other investment industry providers. Learn about our editorial policies. Reviewed by Roger Wohlner. Roger is a veteran financial advisor with more than 20 years of experience and a personal finance writer.
He specializes in writing about a wide range of topics including financial planning, investing, mutual funds, ETFs, k plans, pensions, retirement planning and more. Learn about our Financial Review Board. Article Sources. Your Privacy Rights.
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