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What are the implications of a steepening yield curve?

Personal Finance & Money Asked on March 15, 2021

Pretty straightforward question, with, I imagine, very complex answers. I know the yield curve basically impacts the entire financial system, but I am looking to understand its macro-effects. Here are some postulations that I have surmised… please let me know if they are right/wrong, and what other implications I have missed:

  • Banks do well. They can borrow near the federal fund’s rate (very low) as well as pay savers extremely low interest rates (in money markets, CDs, savings accounts, etc…) while cashing in on higher interest rates for long term borrowing.
  • Equities suffer, particularly those with long term, speculative growth. Since the discount model for stocks contains the interest rate in the denominator, any increasing interest rate should serve to drive down stock prices, regardless of what metric is in the numerator.
  • National debt is reduced. This isn’t directly from the steepening of the yield curve, but rather due to increased inflation. With inflation rising, and even the long term treasuries at lower yields than the inflation, the government essentially is able to borrow money and pay interest that is effectively devaluing, meaning the don’t even need to pay back the full amount (in terms of value). Is this the Fed’s intention?

What is the end goal here? Will the Fed allow the 10 year note to continuously increase so that it can continue to spend its way out of the economic recession, while simultaneously , somewhat, manage the growing debt? Will they, at some point, need to implement yield curve control to get the far end of the curve under control? Do stocks continue to suffer until this point?

Also, is it correct to view this as an endless march towards fiat devaluation? The DXY has been steadily decreasing over the past year and is at its lowest point in 3 years, and there doesn’t seem to be an end in sight.

One Answer

There are too many assumptions in your question. For one thing, you assume that a steep yield curve is the cause of several issues, rather than just being an effect of a broader phenomenon. E.g. a steep yield curve and inflation could both be effects of an optimistic market climate. A flat yield curve and disinflation could be the effects of a pessimistic market climate.

Answered by Orange Coast- reinstate Monica on March 15, 2021

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