(Bloomberg) -- Wall Street is coming down with a case of curve-flattening fever.
After weeks of relentless narrowing of the spread between short- and long-dated Treasuries, strategists have been left with little choice but to contemplate an inverted yield curve when crafting outlooks for 2018 and beyond. Now, they’re warming to the idea that this oft-cited recession signal could flash as soon as next year.
Six of 11 analysts surveyed by Bloomberg since last week said the curve from two to 10 years will invert at least briefly within 24 months, with four calling for it to happen in 2018. Yields on the maturities will meet somewhere between 2 and 2.5 percent, according to the respondents predicting inversion next year. That would coincide with the range the 10-year note has plied throughout 2017.
“That weird combination of decent growth forcing the Fed’s hand to tighten, and on the other hand inflation not running away, biases the curve to flatten,” said John Herrmann, director of rates strategy at MUFG Securities Americas Inc. “Our investment stance is for the flattener to continue in 2018.”
The persistent pancaking of the curve has dominated discussion in the $14.4 trillion Treasuries market in recent weeks as traders war-game what it might mean for monetary policy. A steady increase in shorter-term yields has been a major driver of the trend, as investors price in more rate hikes in 2018.
The two-year Treasury yields 1.8 percent, up from 1.25 percent in mid-September. The gap between two- and 10-year notes, which started the year at 125 basis points, flattened Wednesday to as little 50, the lowest in over a decade.
In Moderation
Most expect the phenomenon to continue, though at a more gradual clip. The strategists surveyed see the spread shrinking to 43 basis points by mid-2018 and to 30 basis points by year-end, based on the median estimate.
Of course, when it comes to the yield curve, one could say that it’s about the journey, not the destination. Here’s how several strategists see the inversion coming about in the next 12 months:
- Ian Lyngen and Aaron Kohli at BMO Capital Markets see a risk of inversion as soon as the Federal Reserve’s March meeting, while they say a flip is more likely around mid-year.
- Extended flattening “has become increasingly consensus -- a dynamic that always gets us nervous, but we’re nonetheless convinced of the fundamentals behind the call,” they wrote in a draft of their 2018 outlook.
- Steven Ricchiuto at Mizuho Securities sees the curve inverting in the second quarter and ending June completely flat, before widening back toward 100 basis points by year-end. That would be the sharpest reversal among analysts surveyed.
- Guy LeBas at Janney Montgomery Scott and Jim Vogel at FTN Financial Capital Markets see the curve inverting in the final quarter of 2018, though ending above zero.
- It’s worth noting that some strategists surveyed didn’t have forecasts for 2019. Bank of America Corp (NYSE:BAC). sees the curve ending next year at 80 basis points, HSBC Holdings Plc (LON:HSBA) at 40 basis points and JPMorgan Chase & Co (NYSE:JPM). at 15 basis points.
- Jay Barry at JPMorgan said the curve would likely compress even further in 2019 if the Fed kept tightening.
The significance of the flattening depends on whom you ask. The survey responses were mixed regarding whether the yield curve remains a reliable recession indicator after years of monetary stimulus.
If you’re in the “yes” camp, that means positioning for a recession in coming years as higher rates choke off economic growth. For those who lean toward “no,” inversion doesn’t carry greater meaning beyond betting against short-dated Treasuries and favoring long bonds.
Either way, Wall Street is gaining confidence that when it comes to the curve, flattening is no fad.