Is the Flattening Yield Curve down to how the Fed is unwinding QE?

in busy •  4 months ago

When an economy is healthy, and there is no interference from either governments or central banks, the yields on long term Treasury bonds tend to be higher than the yields on short-term bonds. After all, you are locking up your money for a long time, and unforseen inflation could erode your money, so you demand a higher yield.

But we haven't been in a normal economy since the Great Financial Crash, which resulted in the Federal Reserve doing a staggering $4 trillion in Quantitative Easing (where they printed money and then bought government bonds, thereby releasing that money into the banking system).

The Fed is now unwinding it's QE - but instead of selling the bonds it has, it is just letting them mature off it's books. (Maturity involves a bond reaching the end of it's term and the government paying back the money it borrowed via the bond - when the Fed receives the maturity payment it just disappears the money, thereby cancelling what it had originally printed to buy the bond).

Because of the way the Fed is unwinding the QE, it is affecting the short end of the yield curve (bonds with less than a year to maturity) pushing yields up. That combined with rising short term base rates is flattening the yield curve.

Traditionally a flattening yield curve signalled an impending recession. See the following image:

yield curve.jpg

But that tradition was formed under normal market conditions where there was no QE distorting things. But nothing in the last ten years has been normal. If QE distorted the bond market, it follows that QT (quantitative tightening) will also distort it.

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You have a minor misspelling in the following sentence:

After all, you are locking up your money for a long time, and unforseen inflation could erode your money, so you demand a higher yield.
It should be unforeseen instead of unforseen.

To the question in your title, my Magic 8-Ball says:

Yes definitely

Hi! I'm a bot, and this answer was posted automatically. Check this post out for more information.

Don't forget all the QE done by the ECB and Swiss National Bank, which they then used to buy dollars to keep their currency down and then invested in Treasuries. That would have held the yield down at the long end.

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There was a story around last year about the Swiss National Bank printing swiss francs and then selling them for dollars and euros to hold down the value of the franc. I guess they parked some of that money in treasuries.

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That's astonishing. I'm sure they didn't mean to manipulate markets like that, but that's the net result.