by Gene D. Balas

Investors are currently preoccupied by whether the economy might enter a recession. The reasons most frequently mentioned have less to do with broad macroeconomic indicators, which generally show moderate growth, and more to do with financial market indicators, such as the volatility in the stock market, rising high yield bond spreads, and the flattening Treasury yield curve.

This is a big topic, so we’ll focus on one issue today – the yield curve – and visit the remaining ones in future posts. It is a timely subject, as we saw the yield of the 10-year Treasury plunge to 1.54% in intraday trading on February 11 in data from Bloomberg, compared to its nearby high of about 2.5% in mid-2015. (It has since rebounded to roughly 1.70%.)

Some of this is indeed due to investors’ concerns about volatility in the stock market and, in particular, the sharp drop in oil prices. The drop in oil prices has several pass-through effects. One is on depressing inflation, complicating the role of central banks in the developed markets which are seeking to increase inflation, which may push out interest rate increases here in the U.S. even further into the future. Another effect is on borrowers in the energy sector, which may find increased difficulty in paying their interest and principal obligations. And a third is the indirect signal the drop in oil prices has on economic health, with concerns of decreased demand (though many indications are that low oil prices are due to overabundant supply.) The end result of these factors is that investors have driven longer term bond yields down as they purchased Treasury securities, leading to a flattening yield curve.

A flattening yield curve has sometimes (or, we might even say, “often”) preceded recessions. So, investors understandably take note. And, without a doubt, the yield curve has flattened, using the difference between the yield of the 10-year U.S. Treasury bond and the 2-year U.S. Treasury note as a guide. The yield curve is now as flat as it was during the Great Recession. What does this suggest?