THE MARKET SEEMS to have found its footing when it comes to inflation. Friday’s Consumer Price Index report was roughly in line with expectations. Recently, there haven’t been any major shifts in the experts’ inflation forecasts. The bond market has also calmed down. Just a few weeks ago, the 10-year Treasury yield neared 1.7%. It settled at 1.49% on Friday.
Volatility could reemerge later this week, however. Data on producer prices post on Tuesday, retail sales hit Wednesday morning and the Federal Open Market Committee issues its rate decision Wednesday afternoon.
More key data arrive on Thursday with housing starts, industrial production figures and the Purchasing Managers’ Index. These readings on U.S. economic strength will all impact the bond market.
Some pundits are growing uneasy about the yield curve—the level of interest rates at various maturities. Normally, short-term yields are low relative to long-term yields. But recently, the short end of the curve has climbed, while the long end remains historically low. The dreaded “inverted yield curve” might be talked about more in the months ahead.
An inverted yield curve is thought to portend an economic recession. The last inversion, when the two-year Treasury yield climbed above the 10-year Treasury rate, occurred in August 2019. The GDP growth rate then turned negative in early 2020. Of course, nobody predicted a pandemic would strike, least of all the bond market.
In the months ahead, the yield curve could invert if traders believe the Fed will raise short-term interest rates. Higher short-term rates mean a tighter credit market, possibly leading to less business activity and reduced consumer spending. That, in turn, might cause long-term interest rates to dip, as investors bet that long-run economic growth could be slightly weaker and inflation somewhat lower.