Flattening the yield curve.

As US policy interest rates continue their ascent (0.25 increase on Wednesday) the yield curve is flattening.

This means short term yields (2 year paper) are increasing at a faster rate than long term yields (10 year paper).

This can be seen by a higher and flatter green curve versus the yellow curve.

If and when short yields exceed long yields, the curve is said to invert.

Inversion indicates higher returns are required to compensate investors for heightened short-term risk - versus a less risky future.

However, to the extent a strong economy and inflation is the cause and investors can see sustainable growth, the longer dated yield should also increase, thereby avoiding an inversion.

At this point the 10 year needle is quivering, but not moving.

Historically, inversion has been an indicator of a coming economic downturn, and due to the Sino-US trade war a fair bit is being written on this potentiality, at the minute.

Now what?

Well, we will need to wait and see whether the 10 year yield reacts, because regardless of the current ‘optics’, the Fed has signaled another rate rise this year and further rate rises next year - and it has not changed pace in removing liquidity from the market by running off bond repurchases.

Here in WA, high demand-USD denominated commodity exports continue to benefit from a stronger USD as US growth and interest rates increase. That in mind, we also need to keep half an eye peeled for downside currency and commodity price risk, in the event of a protracted trade war.

Mike

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