Read the Wall Street Journal (WSJ) Mar 2022 Article "20220322_Flattening Yield Curve Stirs Recession Debate - WSJ.pdf and discuss the following questions: I have copied and pasted the article after the questions. (1) According to the article, in what circumstances are yield curves upward-sloping? (2) According to the article, what factors can lead to a downward-sloping (or "inverted") yield curve? (3) Based on the article, why are some analysts and investors not concerned about the shape of the yield curve? (4) What factors might keep longer-term yields lower than expected in the near term?

Flattening Yield Curve Stirs Recession Debate

By Sam Goldfarb Follow Updated March 22, 2022 4:12 pm ET

Yields on shorter-term and longer-term U.S. government bonds have been converging rapidly, stirring fearsalong with skepticismthat the bond market is close to signaling a looming recession.

Yields, which fall when bond prices rise, have been climbing all year based on expectations that the Federal Reserve will raise short-term interest rates. They got another big boost Monday, after Fed Chairman Jerome Powell emphasized that the central bank was prepared to raise rates in half-percentage steps to fight inflation.

But yields have climbed particularly sharply on shorter-term Treasurys, drawing almost as much attention to differences between yields as to their absolute levels.

Yields on U.S. Treasurys largely reflect investors expectations for short-term interest rates set by the Fed over the life of a bond. At the start of an economic expansion, shortterm interest rates are typically low. But investors expect them to rise eventually, creating steady upward gaps between short- and long-term yields, or what investors call steep yield curve.

Even if short-term rates are seemingly stable, investors have typically demanded higher yields on longer-term bonds as compensation for the risk of unexpected inflation and corresponding rate increases.

Downward-sloping yield curvesin which short-term yields exceed longer-term yields are rarer, reflecting expectations that slowing growth will prompt the Fed to cut rates. Known as inverted yield curves, they have a decidedly bad reputation on Wall Street, having frequently preceded recessions in recent decades.

Todays yield curve isnt exactly downward sloping, but it has been heading in that direction. The gap between two- and 10-year yields has shrunk to around 0.2 percentage point from 0.9 percentage point in early January. Yields on three-, five-, and 10-year notes are all now just under 2.4%.

This trend has set off alarms in some quarters. In a March 16 tweet, former Treasury Secretary Lawrence Summers who has been arguing that the Fed was raising risks of a recession by not tackling inflation more aggressivelysaid he was not surprised that yield curve shape is increasingly pointing towards recession.

Others, including some bond investors, have voiced similar concerns. Still, most on Wall Street seem more sanguine. Stock indexes surged last week at the same time that some shorter-term yields poked above longer-term yields, heightening inversion fears.

Some investors and analysts say there are reasons not to worry too much about the yield curve. For one thing, they note, it isnt really telling investors much that they havent heard from Fed officials already.

Faced with the highest inflation in decades, the central bank last week raised its benchmark federal-funds rate by a quarter of a percentage point to a range between 0.25% and 0.5%. Based on the median of officials estimates, the Fed further indicated that it could raise the fed-funds rate to about 1.9% at the end of this year and 2.8% at the end of 2023 before it settles over the long run at around 2.4%.

The basic message from both the Fed and the market is that the central bank might need to lift rates temporarily above their expected resting level, analysts said. That could lead to rate cuts later but doesnt necessarily spell a recession, they added

In the last economic expansion, the Fed raised the fed-funds rate to between 2.25% and 2.5%. Confronted with a slowing economy, it then cut rates in the second half of 2019 by three quarters of a percentage point. At that point, some longer-term yields had dropped below some short-term yields. Nevertheless, the economy appeared to be in good shape with subdued inflation and extremely low unemploymentwhen the pandemic hit in early 2020.

Some investors and analysts argue that people might have to learn to live with flat and inverted yield curves in the future, due to a range of forces pushing down on long-term yields. Those include demand for Treasurys from U.S. pensions and overseas investors, a long-term trend toward lower interest rates and other factors.

Yield-curve inversion is coming. Its going to happen. But its not going to be the usual doom and gloom that we often associate with yield curves inverting, said Guneet Dhingra, head of U.S. interest-rates strategy at Morgan Stanley.

Investors still have reasons to be nervous. Even if the yield curve is telling them what they already know, it remains true that the Fed is actively trying to cool the economy.

That presents the risk that the Fed could help cause a recession either accidentally, by raising rates more than is necessary, or on purpose, by deciding that a slowdown is needed to avoid a 1970s-style inflation crisis.

Some economists have wondered whether the Fed might become frustrated at some point that longer-term yields arent rising more than they are, precisely because the officials want to slow economic activity. Longer-term yields tend to exert more influence over the economy than shorter-term yields.

Many, though, arent too worried about that now. The Fed has just started to raise rates, and borrowing costs are already much higher than they were just a few months ago.

Last week, Freddie Mac reported that the average rate for a 30-year fixed mortgage had topped 4% for the first time since May 2019, having climbed from 3.22% at the beginning of the year. Mortgage rates have been pushed higher by the increase in the 10-year U.S. Treasury yield and by expectations that the Fed will soon start shrinking its holdings of mortgage-backed securities, analysts say.

Financial conditions have already incorporated a significant number of rate increases, Mr. Powell said in his postmeeting press conference last week. So the clock is running on that, and I think some of that will be seen in the second half of the year as well.

Write to Sam Goldfarb at sam.goldfarb@wsj.com