Inverted Yield Curve Puzzle: Higher Short-Term Yields

In this week’s recession scare, everyone focuses on the 10-year Treasury. But why are yields on T-bills for 12 months and below so high?

The inverted yield curve has given investors the heebie-jeebies lately, as it has long functioned as a harbinger of an oncoming recession. When an inversion happened on Friday, there was a lot of tut-tutting that this inversion wasn’t a real one—because the curve’s short end is the three-month Treasury yield (2.45%), and not the more traditional two-year T-bill.

Aside from the dubious provenance of the three-month bill, the investing world is paying attention to the continued fall of the benchmark yield at the other end of the curve, that of the 10-year note. Due to its status as a refuge amid worrisome conditions outside the US, overseas investors are crowding into the 10-year, boosting its price and lowering its yield.

But few are looking at the goings-on of the short, short part of the curve: the three-month Treasury, as well as the six-month and the 12-month obligations. Namely, their yields have blipped up and now are higher than the two-year (2.25%). Why, though?

“They’re not piling into” the Treasury paper maturing in 12 months or less, noted Marilyn Cohen, president of Envision Capital Management.

Maybe the enticement of the 10-year is simply that the bond has a brand name that impels buying. And that’s even though you’re being paid slightly less in interest for the much greater risk that goes with holding an instrument for a decade, as opposed to a few months: The 10-year ended Tuesday yielding 2.41%, lamentably below the three-month’s 2.45%.

On the short, short end, however, maybe market preferences have less to do with how the shorter-maturity bills are yielding—because the Federal Reserve is driving things at that part of the yield spectrum. Right now, the three-month bill’s yield of 2.45% falls within the Fed’s target rate range of  2.25% to 2.50%.

Go back to March 2018, and that’s true of its yield then (1.79%) for the range at the time. And such also was the case with March 2017’s yield of 0.78%.

Should the Fed actually cut rates, as some predict, the yield curve would likely not bump skyward at the 12-month mark and less.


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