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Explainer-Why is the yield curve flattening and what does it mean?

By David Randall

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Explainer-Why is the yield curve flattening and what does it mean?
© Reuters. FILE PHOTO: People are seen on Wall Street outside the New York Stock Exchange (NYSE) in New York City, U.S., March 19, 2021. REUTERS/Brendan McDermid

By David Randall

NEW YORK (Reuters) – A surge in the yields of short-term U.S. government debt has investors focused on the shape of the Treasury yield curve, where the yield advantage that longer-dated securities usually hold over shorter-dated ones is on track to narrow at its fastest pace since 2011.

Money managers and economists often view a shrinking of the gap between yields on shorter-term Treasuries and those maturing out years – known as yield curve flattening – as a sign of worries over economic growth and uncertainty about monetary policy.

Here’s a quick primer explaining what a flat yield curve is and how it may reflect investor expectations.

WHAT IS THE U.S. TREASURY YIELD CURVE?

The U.S. Treasury finances federal government budget obligations by issuing various forms of debt. The $14.8 trillion Treasury market includes Treasury bills from one month out to one year, notes from two years to 10 years, as well as 20-and 30-year bonds.

The yield curve plots the yield of all Treasury securities and investors watch its shape to extrapolate market expectations for U.S. growth and monetary policy.

Typically, the curve slopes upwards because investors expect more compensation for taking on the risk that rising inflation will lower the expected return from owning longer-dated bonds. That means a 10-year note will often yield more than a 2-year note because it has a longer duration. Yields move inversely to prices.

From time to time the yield curve can invert, a phenomenon that is considered bad news for the short-term economic outlook and has presaged past recessions.

WHY IS THE YIELD CURVE FLATTENING NOW?

The Federal Open Market Committee is widely expected to announce at the conclusion of its November monetary policy meeting on Wednesday that it will begin tapering its $120 billion-per-month bond buying program.

While that move has been well-telegraphed to investors, some are starting to worry that surging inflation will force the central bank to unwind its bond buying faster and eventually raise interest rates sooner than investors had expected.

Expectations of sooner-than-expected rate increases have pushed short-term yields higher in recent days. Longer-term ones have fallen in part due to bets that a potentially more hawkish rate policy will successfully tamp down inflation, precluding the need for raising borrowing costs as high as previously projected over the longer term, analysts have said.

Rate increases can be a weapon against inflation, but they can also slow economic growth by increasing the cost of borrowing for everything from mortgages to car loans.

The Federal Reserve has signaled that it does not expect to raise interest rates until next year and that borrowing costs should rise to at least 1% by the end of 2023 from its current rate of 0 to 0.25%. [L1N2RO2FM]

IS THE ENTIRE YIELD CURVE USUALLY UPWARD SLOPING?

No. Distortions can occur anywhere along the curve without inverting the entire curve. On Thursday the yield on the 20-year bond rose above the 30-year bond.

ARE OTHER COUNTRIES ALSO SEEING FLATTER YIELD CURVES?

The phenomenon is not confined to the United States. Short-term rates have climbed in Australia, Germany, Canada and other countries where central banks are projected to tighten monetary policies at a faster-than-expected pace.

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Economy

Costs of electricity in Italy rose by more than 76% in August

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cost of electricity in Italy

Costs of electricity in Italy rose by 76.4% in August, compared with an average of 51.9% in the euro area. La Repubblica writes about it, citing the estimates of Italy’s Confartigianato, an association of small and medium-sized businesses.

“Italy has structural problems. Here the cost of gas and electricity has always been very high because of the nature of production and the fact that there has never been an appropriate energy plan. Therefore, the average electricity bill in Italy will continue to rise,” said the head of Confartigianato, Bruno Pannier.

According to him, now Italy can concentrate on the production of energy from renewable sources. In this matter, the country is in a better position than other countries of the European Union, in particular due to the climate.

The newspaper said that in July electricity and gas prices in France jumped by 23.8%; in Germany – by 46% and in Spain – 54.3%, while in Italy the increase was 59.1%.

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Economy

The situation in Europe is worsening. Rising food and energy prices are becoming a growing problem

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rising food and energy prices

The situation with rising food and energy prices in the EU soon will only get worse. This follows from the statement of the head of the European Central Bank Christine Lagarde.

British residents have already spent more than half of their savings. According to The Times, monthly expenditures on British energy prices are growing by a record £145. The pound itself reached a historic low against the dollar and almost equaled it. The sharp decline occurred after the decision of the British government to reduce taxes in the country.

Against this backdrop, Parliament began to prepare a vote of no confidence in the new Prime Minister, Liz Truss, who proposed new economic measures. The situation in Germany is also difficult. As German Finance Minister Christian Lindner admitted, he does not yet know how to fight gas prices.

“We are working in parallel with the commission on gas prices, which was created by the federal government. And so we will be looking for ways in which we can put price control into practice. I have an idea of what direction to think, but I don’t really want to go into all the details,” Ridus said.

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Economy

Nord stream sabotage? “Nord Streams” is almost completely out of order due to malfunctions

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nord stream sabotage

The Nord Stream and Nord Stream 2 gas pipelines are almost completely out of service due to various faults. Many are voicing opinions about sabotage on Nord Stream.

Both gas supply routes to Europe via the Baltic Sea bed are out of service. First there was the Nord Stream 2 accident, where the pressure on one of the lines dropped drastically. The cause of the leakage is currently being investigated. Then pressure dropped in both strings of Nord Stream, but the reason for the drop in pressure is still unknown. There are serious reasons to assume a Nord Stream attack.

The publication noted that the German authorities have already started working with the Danish authorities and local law enforcement agencies to find out the reason for the pressure drop in Nord Stream-2. However, it is not clear how the pipeline will be repaired, as it is under U.S. sanctions and bankruptcy proceedings, although it has been postponed until January 2023.

At the moment it is impossible to name the exact cause of the malfunctions that have occurred. However, the sudden drop in pressure may indicate not just a leak, but a much more serious problem. Also, this accident could have certain consequences for the entire gas market, and repairs could take quite a long time.

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