The yield curve flattened further last week as the risk of a spreading trade war is driving prices

The economic data continues to come in above expectations and well above the level of the first quarter. None of this data is driving financial markets. Investors are more concerned about the escalating trade war that has unfolded. Europe, Canada and China have reacted to the tariffs we have imposed by increasing tariffs on our exports to them. Investors are concerned this will lead to a slowdown in economic growth moving forward. At the same time, inflation will be higher as companies raise prices to offset higher costs from imported raw materials and finished goods. Will Walmart absorb the higher cost of products made in China due to tariffs or will they raise prices to maintain slim margins? Investors believe Walmart will raise prices which will slow sales. This risk has driven stock prices lower with capital moving from stocks into bonds. The yield on the ten-year treasury has dropped from over 3% to 2.88% over the last month as these tariffs have been implemented. The yield curve has flattened further with the spread between the yield on the two-year and ten-year treasury dropping to less than 40 basis points at the end of last week. The short end of the curve is pricing two more increases by the Fed over the next six months and holding the rates in the short end up while the intermediate and long end decline.

ProBank Austin Advisor-June 25, 2018