U.S. Yield Curve Inverts Again: What Is It Telling Us?

• One of the closely watched parts of the U.S. Treasury yield curve inverted on Monday for the first time since April following hotter-than-anticipated inflation data last week. As the U.S. Federal Reserve attempts to bring inflation down from 40-year highs, banks have ramped up projections of interest rate hikes, and some shorter-dated bond yields surged higher than longer-term ones. 
• The yield curve, which plots the return on all Treasury securities, typically slopes upward as the payout increases with the duration. Yields move inversely to prices. A steepening curve typically signals expectations for stronger economic activity, higher inflation, and higher interest rates. A flattening curve can mean investors expect near-term rate hikes and are pessimistic about economic growth. An inversion, however, signals that a recession could follow. 
• The 2/10 part inverted, meaning the two-year Treasuries yielded more than the 10-year paper. Short-term yields, which are sensitive to interest rates, are rising with rate-hike expectations while higher long-term rates reflect concerns that the Fed will be unable to control inflation. 
• That part of the curve had inverted in late March for the first time since 2019. It steepened again as traders, having priced in a string of rate hikes, sharpened their focus on the pace and scope of the Fed's plans to reduce its balance sheet. 
• While rate increases can be a weapon against inflation, they can also slow economic growth by raising borrowing costs. When short-term rates increase, U.S. banks tend to raise benchmark rates for a wide range of consumer and commercial loans, including small business loans and credit cards, making borrowing more costly for consumers. Mortgage rates also rise.

(Source: Reuters)