In a video shared on the Fisher Investments YouTube channel, Ken Fisher explains the yield curve and why it’s important. There’s been a lot of conversation about the yield curve in recent weeks, Fisher says, but a common interpretation of it is incorrect.
That wrong interpretation says that the yield rate, represented by the 2-year government bond rate subtracted from the 10-year government bond rate, has narrowed so much that it will invert, which will cause a recession. While the yield curve is an indication of government debt, from short-term to long-term debt along with all of their interest rates, traditionally it’s been thought that when the short-term rate flattens or rose above long-term rates, that could signal a recession. However, the curve itself isn’t important, Fisher maintains; instead, “what’s important is what that represents that would cause recession.” And what that is, is the core of banking: “taking in short-term deposits as the basis for making long-term loans.”
The wider the spread between those two points is, the more profits banks make. As that spread gets bigger, banks are more willing to lend money out to make that profit, and that lending is “expansionary,” Fisher explains. Lending leads to higher consumer and corporate spending. But when the banks won’t lend, that becomes a problem. Furthermore, if short-term rates shift above long-term rates, then banks have to lend to less credible borrowers at a higher rate in order to make profits. That, in turn, increases risk.
Since it’s the lending that matters, Fisher says you shouldn’t pay attention to the spread between 2-year bond rates and 10-year bond rates. Not much lending that happens is based on 2-year deposits; most of it is short-term deposits such as 30- or 90-day. That curve currently isn’t very narrow; it’s at almost 2%. That curve is comfortable enough for banks to borrow at and lend against to make money. Fisher advises searching Google regularly for the annual rate of bank loans, both in the U.S. and globally, to keep tabs on “how that’s proceeding over time,” and adds that right now, “it’s proceeding very well, thank you.”