One of the biggest indicators of an economic downturn might not be predicting one this time

BUY quality bulk Yahoo Twitter Hotmail Google Voice Facebook Accounts
tusweet323 48yo Detroit, Michigan, United States

Fortune Teller Reuters/Mihai Barbu

The US Treasury yield curve has flattened recently, which often suggests an economic slowdown.
But this time around, short-term rates seem to be reacting to a more hawkish Fed.
That means it's quite possible that the economic expansion could keep going for a few more years, despite the curve flattening.

The U.S. Treasury yield curve has flattened for much of 2017, and spreads between long and short maturities recently narrowed to decade lows. This is usually a late-cycle phenomenon indicating flagging growth—but not this time around, in our view.

The yield curve compares interest rates at different maturities. Investors tend to focus on the spread between yields on two- and 10-year bonds. Ten-year yields reflect the market’s growth and inflation outlook. The short end of the curve is mainly tied to market expectations for Federal Reserve (Fed) policy rates.

yield curve BlackRock

This shows greater market confidence in the Fed nudging up rates mainly due to the better growth and inflation outlook. It would be worrying if the curve had flattened because 10-year yields were falling on concerns that Fed policy tightening might crunch growth and inflation.

Instead, low inflation expectations have kept rises in 10-year yields in check, while declines in yields on even longer maturities largely reflect strong foreign buying and demand from institutions seeking to hedge risk.

We see a sustained global and U.S. economic expansion. Our BlackRock Growth GPS points to steady and above-trend developed market growth of around 2%. Such solid growth and a return of mild inflation expectations have kept the Fed on track to lift interest rates later this month and at least three more times in 2018, in our view.

We believe the Fed is unlikely to cut the expansion short with its steady interest rate rises and balance sheet reduction. We see the current fed funds rate as well below neutral levels (neither easy nor tight), and monetary policy remains highly expansionary. Our analysis of economic slack gives us conviction that this expansion’s remaining lifespan can be measured in years.

The flatter yield curve is not a recessionary signal, so what is it telling us? Much of this year’s earlier yield curve flattening represented a reversal of the 2016 steepening that accompanied surging economic growth and inflation expectations after the U.S. presidential election.

Markets had bet that fiscal stimulus and infrastructure spending would spur growth and inflation. Long-term yields jumped in response. Those market expectations unwound over the course of 2017 when policy changes were slow to materialize and weak inflation readings became the big surprise.

Persistent demand for long-term Treasuries pushed 30-year yields lower even as short-term rates rose. We could see long-term Treasuries rising a bit from here—but expect low-trend growth, plentiful global savings seeking income and other structural factors to keep them historically low.

Our outlook for growth and inflation supports our preference for equities, including cyclicals—despite the flat yield curve. Within U.S. fixed income, we like Treasury inflation-protected bonds over nominal government debt. Read more market insights in my Weekly Commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

NOW WATCH: What happens to your brain and body if you use Adderall recreationally