Under Pressure

Queen teamed up with David Bowie in 1981 to create Under Pressure which topped the UK’s singles chart.  Search the internet for an interpretation of the lyrics and you’ll find oodles of opinions.  When you’re done reading this note, take a listen here and tell us what you think.  In the meantime, let’s look at an area of the market for which the song could be a metaphor: the yield curve.

A yield curve is a visual representation of interest rates.  It plots rates of similar assets with different maturities.  One commonly referenced example is the U.S. Treasury yield curve.  This illustrates the different rates the bond market is offering over various periods of time when lending to the federal government.  During times of prosperity, it tends to be upward sloping (i.e., longer-term bonds pay higher interest rates than shorter maturities).  However, on rare occasions, the slope turns negative (a.k.a. inverted), often signaling troubled times are likely ahead.  It’s premature to sound an alarm just yet, but rate changes from the Federal Reserve are influencing the steepness of the slope.

Overnight interest rates have been raised five times since December 2015 and are likely to be raised for a sixth time in September.  During the same period, the ten-year Treasury yield has stayed relatively stable, causing pressure between these two points on the curve.  In fact, the rate differential between a two-year and a ten-year bond is virtually at the lowest level in the current economic expansion.  While not yet inverted, the squeeze is on. 

Will market participants allow the curve to invert?  There is no way of knowing.  If it does invert, calls that the next recession is imminent will grow louder.  For now, the yield curve is the most significant possible fly in the ointment, but it hasn’t even landed since a slightly positive slope remains.  In the meantime, many of the indicators Atlas follows remain constructive.