Flat US Yield Curve Is Big Question for Parade of Fed Speakers

It's hard to overstate the flattening move in the U.S. yield curve. Select just about any two maturities, and the gap between them has shriveled over the past year.

At one point last week, investors picked up a mere 2 basis points for owning 10-year Treasuries instead of seven-year debt. Strategists at BMO Capital Markets said in a report Friday that if that portion of the curve inverts, others are likely to follow, possibly within 25 to 35 trading days.

It's far from certain the Fed will slow down as the curve flattens, given the new make-up of the voting body. Kansas City Fed President Esther George, possibly the most hawkish U.S. central banker, is likely to vote on the Federal Open Market Committee for the first time since 2016 as part of a reshuffle with the retirement of New York Fed President William Dudley.

Nor is it clear they should take their feet off the gas. Though rooted in Fed policy and low inflation, the flattening has been sustained by Treasury supply and demand trends. The government is concentrating the auction-size increases required to finance wider deficits in short maturities, while pension funds' appetite for long maturities is expanding, TD strategists said last week.

Traders, for their part, are betting on persistent rate hikes. In fact, fed fund futures are pricing in between two and three additional increases this year, which is above the central bank's forecast of two more in 2018.

The economic data of late have supported the market's view. The Fed's preferred inflation gauge reached 2 percent for the first time in 13 months, while the unemployment rate is below 4 percent, which hasn't been seen since the turn of the century.

The Fed doesn't have a mandate to monitor the shape of the yield curve, of course. But officials in the days ahead may still have to answer for its relentless flattening.

— Check out How Are Yield Curves and Recessions Related? Not How You Think: Recessionomics, Pt. 1 on ThinkAdvisor.