The next move

The yield curve is out of inversion, but it's not exactly steep either.

The 30-year minus 3-month spread bottomed near -1.7 points in 2023, one of the deepest inversions in four decades. Today it sits around +1.2. That's positive, but well below the 3 to 4 point spreads we saw coming out of past recessions.

So what could move it from here? It comes down to three variables.

1. Inflation

- Sticky or re-accelerating inflation pushes long yields up as investors demand more compensation. That means a steeper curve, and a bear steepener if the Fed stays on hold.

- Inflation falling faster than expected pulls long yields down, which flattens the curve unless the Fed cuts aggressively.

2. The deficit

- Heavy Treasury issuance and bigger deficits raise the term premium. That pressures the long end and steepens the curve even if the Fed does nothing.

- Credible fiscal consolidation would do the opposite and compress term premium.

3. The Fed's response

- Cuts driven by a weakening labor market bring short rates down faster than long rates. That's a bull steepener, and historically it's what the curve does going into a slowdown.

- A hawkish Fed forced to hold or hike on inflation lifts the front end, and the curve flattens or re-inverts.

The four possible scenarios are:

1- Inflation sticky + big deficits + Fed on hold → bear steepening

2- Growth slows + Fed cuts → bull steepening

3- Inflation re-accelerates + Fed turns hawkish → flattening or re-inversion

4- Growth scare + flight to quality → long yields fall, curve flattens

The curve isn't a crystal ball. It's a real-time scoreboard of how the market is weighing inflation, fiscal risk, and central bank credibility. We’re getting close to the tipping point.

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