Does a flattening yield curve mean recession is looming?


A flattening yield curve has been a reliable leading indicator of past economic slowdowns, but this time around may be different. Aubrey explains.

What does a flattening yield curve mean these days? Perhaps not what it used to.

No doubt, the slope of the yield curve, as measured by the spread between two- and 10-year government bonds, has been flattening since 2014 in both Canada and the United States, and the trend has recently intensified: as we headed into December, the curve sat at its flattest level since the Great Recession.

Fixed Income 101 tells us that this foreshadows slowing economic growth. More worrisome, when the two-year/10-year spread hits zero, or less (yield curve inversion), that’s generally considered a slam-dunk for impending recession.

iSH Blog Flattening Yield.1

So says the textbook. But we acknowledge that some unusual factors are driving the curve flatter in the post-recession era, and they might not signal slowdown or impending recession:

  • Lower potential growth in this cycle, in which case the curve should be flatter than in previous expansionary phases
  • Inflation expectations are low, justifying lower risk premia for long bonds.
  • Canadian and U.S. central banks are in a hiking cycle, raising short-term rates, which adds to the flattening.
  • Monetary policymakers in Japan and Europe are still engaged in quantitative easing, which is suppressing long yields and driving Japanese and Euro bond investors elsewhere. That’s suppressing long yields in North America.
  • The trend toward pension plan de-risking and insurance companies hedging their long-date liabilities has created a huge demand for duration – which, again, is flattening the curve.

And yet, against these perhaps-unique factors, the yield curve may still be foreshadowing a slowdown. After all, the era of easy money may be coming to a close. That has negative implications for growth, for both structural and historical reasons.

So while we can see the extenuating circumstances creating a flatter yield curve, we’re not quite ready to declare that it’s different this time. In fact, we believe that the curve is telling investors to tread carefully and be cautious, in particular, when it comes to risk asset allocation.

Aubrey Basdeo is a Managing Director and Head of Canadian Fixed Income for BlackRock. He is a regular contributor to The Blog in Canada.

Rachel Siu, vice president and member of the product strategy team within BlackRock’s Global Fixed Income group, contributed to this article.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

© 2017 BlackRock Asset Management Canada Limited. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission. 319880