The Yield Curve is Flattening

Hello All! one of the key fundamentals you should follow in the financial world is the Yield Curve. This is a Wall Street metric that can effect main street more than Wall Street. I have noticed a disturbing trend with the curve spread; see for yourself below:

2s/10s Yield Spread as of 02/22/2019

What this chart is showing is the spread between a 2 year U.S. Treasury and a 10 Year U.S. Treasury. So if you loan money to the United States with a 2 year repayment term you could received 2.4% or if you wanted a 10 Year repayment term you could received 2.6%. Do you see the issue with this?

If you do not see the issue with this then think about it this way? if the Treasury will not issue a premium for long term loans; then why should (and how would banks); therefore banks’ only incentive to loan is for the short term, not the long term. Since many American citizens and American businesses have been drunk on debt for the past decade; this could prove troublesome. What long term loans do you, the average person, currently have or would be willing to assume? (Hint: a house).

A flat yield curve is nothing to worry too much about within the scope of the yield itself. It could be a short term issue that self corrects and curve will normalize. Or; the yield can keep its descent and become inverted. This is where interest rates for the long term are lower than interest rates in the short term. In this scenario long term lending generally ceases altogether because financial institutions can receive greater returns for lending for the short term. In 2006, the yield curve reached -0.11; which meant 2 year loans could fetch 4.75% and 10 year loans would earn 4.64%; so why would any sane person lend at 10 years instead of 2? The real estate bubble was fueled through ever increasing debt and when banks stopped making long term loans; well, you know what happened next.

The kicker here is that an election cycle is approaching. Depending on President Trump’s influence; he may be able to convince the Fed to take a dovish stance and proceed with another round of Quantitative easing. This may delay any calamities until after the election cycle if executed properly.

How I plan to handle this scenario is a bit unique and may not fetch the highest reward, but it does come with reasonable risk tolerance. I will not be selling any positions; but I will now halt purchases as well. I will be sidelining outstanding cash positions to wait for the day when stocks have a fire sale. However, I do plan to continue to reinvest the dividends.

Good Luck out there!

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