Bond Yields: Flattening, in a good way

Written by: Global Thought Leadership | November 17, 2017

Source: Bloomberg and Legg Mason,11/15/17. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • The news that the US Treasury yield curve is flattening has been taken as an ominous sign by many investors skeptical about the equity and bond markets now. 
  • And indeed it can be; when flattening leads to a so-called “inverted” curve, where long-term rates are lower than short-term rates, recessions have often followed.
  • Among the rationales is the belief that falling long-term yields reflect pessimism about the near-term state of the economy.
  • But there are reasons to welcome, rather than fear, the shifting shape of the yield curve.
  • First, the curve is moving most at the short end – with the rise in short-term rates a direct result of the Fed’s policy moves. Contrast the rise of 78 basis points (bps) for 6-month notes, vs a fall of 28 bps for 30-year bonds.  
  • Second, the falling rates at the long end of the curve reflect the low inflation present in many parts of the U.S. – which can be a boost to future growth as the costs of production stay low, rather than a signal of a slowdown
  • Perhaps most important: despite the tilt, the yield curve suggests that the market remains willing to pay investors for borrowing their money.  An inverted curve suggests the opposite: that cash in hand is worth more than cash invested in the bond market – a pessimistic outlook indeed.
  • Whatever twists and turns may await us in the Treasury market, investors should consider what skilled active fixed income managers may be able to do amid shifting conditions across all sectors of the bond market. 

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