The government bond yield curve in the US is upward sloping, which is what a normal yield curve should be. Let us analyse why US yield curves are normal.
Chart 1 shows the upward sloping US treasury yield curve.
The yield on the one year US treasury is close to zero per cent largely because the US Federal Reserve (Fed) is maintaining its benchmark policy rate, the Fed fund rate in a 0% to 0.25% range. The Fed has guided markets that it will maintain the policy rate in the 0% to 0.25% range for at least two years. The Fed is also providing enough liquidity to the system in order to keep interest rates down in the economy
The Fed fund rate is the rate at which banks in the US lend overnight funds to each other in order to maintain their statutory reserve balances with the Fed. The lower the Fed fund rate the lower the overnight lending and borrowing rates and vice versa.
The Fed uses the Fed fund rate as a signalling tool on where it wants the economy to go. The US economy has faced issues of rising unemployment (unemployment rate rose by over 3% post the credit crisis of 2008) and rising unemployment rates leads to a sluggish growth in the US economy as consumers have less disposable income to spend. The Fed by keeping the Fed funds rate in a 0% to 0.25% range is trying to help the US economy reduce unemployment to grow at a faster rate.
The fact that yields are progressively higher in five, ten and thirty year maturity bonds suggest that the US treasury market is factoring in a potential rise in one year rates down the line. The reason short term rates are likely to go higher down the line is that the present low interest rates will help the US economy grow and as the economy grows, inflation expectations will rise and the Fed will then have to raise the Fed funds rate to counter an inflation threat.
The US yield curve has steepened over the last few weeks. Five, ten and thirty year bond rates have risen by 20bps, 40bps and 35bps respectively while one year treasury yields have been flat. The rise in yields on longer maturity bonds are suggesting that investors are shifting out of low yielding government bonds into growth assets including equities. US equities have been the best performers over a one year period with gains in the S&P 500 at over 10%. Equities are reflecting the future growth expectations in the US economy as suggested by the yield curves.