Signs of economic recovery are blossoming everywhere, and one key indicator is showing strong numbers. The indicator also reveals that investors are no longer so pessimistic about the future and feeling inclined to take on more risk in the markets and exchange traded funds (ETFs).
The yield curve, which measures the difference between shorter-term 2-year notes and longer-term 10-year note yields, narrowed a little after touching a record high on Tuesday, reports Hibah Yousuf for CNNMoney. The yield curve is a key indicator as to the health of the U.S. economy.
The figure reached a record high of 2.86%, indicating investor optimism when it comes to riskier assets, such as stocks. The historical average is 1.5% and the average in the last year is around 2.15%.
When the spread of the interest rates between the two notes widens, or the yield curve rises, it usually means that the economy is recovering. A narrowing or negative spread is an omen of ominous times to come. The yield curve steepens when the Federal Reserve reduces interest rates to stimulate the economy.
Once the Fed decides to rein in its cheap lending and start raising interest rates, the yield spread will probably narrow, since the 2-year note yields will have to play catchup, says Peter Cardillo, chief market strategist at Avalon Partners. Betting on an expanding economy and rising inflation, investors are selling long-term bonds, which have sent prices lower and yields higher – Treasury prices and yields move inversely with each other.
The yield curve is also good for banks, which borrow at short-term rates and lend at long-term rates. This translates to more profits and, ultimately, more free-flowing credit, comments Mark J. Perry for iStockAnalyst.
The yield curve was last seen hovering around this high level in 1992 and 2003 – both times, the economy was emerging from a recession.
For more information on Treasuries, visit our Treasury bond category.
- iShares Lehman 7-10 Year Treasury Bond Fund ETF (NYSEArca: IEF): down 5.9% year-to-date; yield is 4.11%
- iShares Lehman 1-3 Year Treasury Bond Fund ETF (SHY): up 0.7% year-to-date; yield is 2.31%
- SPDR Financial Select Sector (NYSEArca: XLF): up 17.1% year-to-date
Max Chen contributed to this article.