Will The Yield Curve Finally Uninvert?

On today’s show we are taking a look at something that has been happening in the bond market during the holiday period while much of the western world has been distracted and not paying attention. Of course the mainstream media is fixated on the instability in the Middle East and rightly so. The situation in Israel, Gaza, Syria, Lebanon, Yemen, Saudi Arabia, and Iran is carries a very real risk of a larger and very serious regional conflict. 

While all of this is happening, the yield curve which has been steeply inverted for much of the past two years is on the verge of becoming uninverted. When the yield curve is normal, long term rates are higher than short term rates. Intuitively, it makes sense that long term rates should be higher. The farther you look out into the future there is more uncertainty and therefore you should expect to pay a premium for that uncertainty. 

Economic conditions and market conditions should be more predictable in the short term and subject to less fluctuations and therefore the interest rate you pay for money should be lower due to the lower uncertainty.

That is the normal situation. Yield curve inversions are a little bit like atmospheric inversions. They can and do occur, but they are not very stable and don’t stay inverted for very long.

When you have an interest rate inversion there are only two ways for the curve to uninvert. Either the long term rates rise above the short term rates, or the short term rates fall below the long term rates, or some combination of these two factors.