The Normalization of the Yield Curve

Hi everyone!

I’ve written quite a lot about the yield curve and it’s significance, but also about the strange place it finds itself in.

So here I am writing about it again.

Why it matters: The 10-year Treasury yield rose above 4.5%, not because of a government shutdown, well maybe a little bit because of that, but because of the notion that the economy is too strong for rates to come down.

The yield curve is the most reliable signal, in terms of occurrence (not timing), for a future recession.  And the steepness — the difference between a 0% inversion and a -1% inversion — tells us the confidence among investors that a recession will occur.

So with the inversion hitting around -2% in the middle of 2022, many investors were confident that we were entering a recession, which is also emblematic of the stock market’s performance in 2022.

The rally in longer dated bond yields marks an interesting turn of events. Typically the yield curve normalizes because a recession hits and the Fed is forced to lower rates — the Fed has heavier influence on short term rates — which causes the short term rates of the yield curve to fall below the longer term rates. Today the longer terms rates are moving to rise above the high short term rates.

Ultimately that works out of favor with the $5 billion that has moved into those bonds in the last 3 months, because they just got a nasty unexpected haircut on price.

What it means for you: What is nice is those who pull around 4%/year from their investment account now have the option to lock in 4.9% rates over the next 30 years. Holding a 30 year bond will be a bumpy ride, however, and real rates aren’t/potentially won’t keep up to 4% withdrawal rates, which leads to a need for stocks and portfolio growth in the long run.

And it certainly doesn’t replace stocks, a 20% rally in the stock market (which oddly enough happens more often than it doesn’t) is far better than 5% nominal in a 30 year Treasury.

And if you draw from a pension, social security, or have insurance 5% nominal yields will also help to make sure those plans can keep up to their liquidity demands.

These higher interest rates ultimately allows people and institutions to take unneeded risk off the table to make sure they are covered in case of a short term need.