Watch out for the yield curve


“An inverted yield curve doesn’t cause a recession,” said Matt Toms, chief investment officer for Voya Financial. “People get confused about the causality on that front.”

It does, however, provide a strong reminder that economic cycles and bull markets don’t last forever. Toms, for one, thinks the Federal Reserve Bank will pause on its path back to “normal” monetary policy to avoid an inversion of the curve. “Chairman Powell is a markets person,” said Toms. “We think the Fed will stop pushing and the curve should begin to steepen by year-end.”

Bob Miller, head of the U.S. multisector fixed-income team at BlackRock, also thinks the Fed will try to avoid a curve inversion. “It’s possible that the yield curve inverts, but I think it’s unlikely,” he said. “We think the Fed will be sensitive to that possibility, and if the 10-year Treasury yield fails to rally, the Fed will signal that quarterly rate hikes are too aggressive.”

The flattening yield curve may not be as good a leading indicator of the economy as it has been in the past, anyway. While economists and market analysts never like the “this time is different” argument, the post-financial crisis environment is clearly unlike previous economic cycles.

More from Fixed Income Strategies:
Protecting fixed-income investments from inflation
Impact investing for fixed-income investors
Bonds dominating fixed-income portfolios is an outdated idea

“The curve is suggesting that long-term growth will slow, but it is sending a weaker signal about the economy than it has in the past,” said Jim Caron, a portfolio manager and member of the global fixed-income team at Morgan Stanley.

For one thing, the $4-trillion-plus portfolio of long-term bonds the Fed is holding is still depressing long-term bond yields. Quantitative easing was specifically intended to reduce the term premium for longer maturity bonds in order to support the economy post-financial crisis, and it has succeeded. Last year the Fed estimated that the large-scale asset purchases (LSAPs) and maturity extension program (MEP) it instituted between 2008 and 2014 reduced the term premium on the 10-Treasury bond by about 100 basis points.

With the Fed now paring back its portfolio — by reinvesting less of the proceeds of maturing bonds — the premium reduction has likely fallen to about 40 basis points, according to Caron. “If you adjust for quantitative easing and its effect on the term premium, things start to look more normal,” he said.

Several other factors beyond economic and inflation expectations are also depressing long-term interest rates. The biggest may be the divergence of global central bank policies.

Source link

Products You May Like

Articles You May Like

This change to 401(k) plans could get you to save more
Wall Street sees major growth potential for Luckin in untapped Chinese coffee market
Stocks making the biggest moves midday: Broadcom, Chewy, Blue Apron
Puerto Rico’s oversight board strikes $35 billion restructuring deal with commonwealth’s bondholders
Chernobyl sees a spike in visitors as pop culture influences tourism

Leave a Reply

Your email address will not be published. Required fields are marked *