A Tale of Two Yield Curves

By Daniel Kruger, bond market reporter

Investors and Federal Reserve officials watch the gaps between shorter- and longer-term interest rates to gauge the health of the U.S. economy. Right now, the two groups are seeing different things.

That’s because they use different measures. Fed economists tend to study the difference between the yield on the three-month Treasury bill and the yield on the benchmark 10-year Treasury note. The three-month yield this year has periodically exceeded the 10-year yield, a phenomenon known as an inverted yield curve that has preceded every recession since 1975.

Many investors, however, prefer to watch the gap between the yields on 10- and two-year notes, saying moves in two-year debt can reflect expectations for Fed policy over a longer period than just the next meeting or two. And the two-year yield has held below that of its longer-term counterpart.

The benchmark 10-year Treasury yield settled Monday at 2.416%. That was 0.193 percentage point higher than the two-year yield and 0.034 percentage point higher than the rate on three-month government bills. The three-month yield most recently exceeded the 10-year yield on May 15.

One reason for the difference: the yields on two-year Treasurys reflect growing odds that the Fed will lower interest rates during the life of the debt, some analysts said. Investors aren’t betting that’s likely within the next three months, which is why three-month yields are about a quarter of a percentage point higher.

The risks facing the economy make Treasury debt maturing in two- to five-years attractive, pulling yields lower than those on shorter-term bonds, some investors said. While few forecast an imminent recession, trade tensions have spurred fears about the prospects for growth and a potential erosion of inflationary pressures that could lead to rate cuts.

The economy grew at an annualized 3.2% in the first three months of 2019 while the jobless rate fell to an almost-50-year low of 3.6% in April. Yet three measures of inflation data for April fell short of economists' expectations, reinforcing the Fed’s recent concerns about softening price pressures.

“It’s difficult to argue that the economy is weakening,” said Donald Ellenberger, head of multisector strategies at Federated Investors. At the same time, “the Fed is desperately trying to push inflation up,” he said.

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