Defined Benefit
Defined Contribution
Insurance Assets

Why the Yield Curve Is Really Curving

Why the Yield Curve Is Really Curving
2 min 37 sec

The U.S. Treasury yield curve has steepened dramatically since the start of 2021, with the 10-year yield rising nearly 70 bps while short-term rates remained close to 0%. While still negative, real yields also have risen, by roughly 50 bps since the start of the year. This movement is significant, as the shape of the Treasury yield curve reflects investor expectations for future inflation, which erodes the value of fixed income investments.

The yield curve typically slopes upward, meaning that longer maturity bonds carry higher yields than shorter maturities. Investors demand higher yields as compensation for buying bonds with longer maturities, as these bonds are more exposed to risks such as inflation.

As the pandemic took hold and economies around the world shut down in March 2020, growth and inflation expectations fell sharply, prompting the Federal Reserve to cut short-term rates to effectively zero and enact large-scale asset purchase programs. As a result, yields on short-term U.S. Treasuries have remained close to 0%.

As prospects for growth have brightened on the back of increasing vaccinations, a gradual re-opening across the country, and continued fiscal stimulus, yields on longer maturity bonds have risen while short-term rates have been anchored by the Fed. This shift in the yield curve is known as a “bear steepening,” meaning long-term yields are rising faster than short-term yields. The “bear” reflects the decline in bond prices associated with rising yields. This steepening reflects expectations for higher inflation and is often associated with the beginning of an economic expansion.

U.S. Treasury Yield Curve

What are the ripple effects for institutional investors of rising longer-term yields and higher inflation? Because bond prices fall when yields rise, investors may experience losses in the short-term. However, longer-term, higher yields are beneficial to bond investors, as coupon income is reinvested throughout the life of the bond. And should the U.S. experience a true uptick in inflation, the Federal Reserve would likely tighten monetary policy by raising short-term rates or slowing asset purchases. As the Fed raises rates, companies face higher costs for borrowing, which may reduce earnings and slow capital expenditures, depressing stock prices. Further, rising yields can make stocks less attractive on a relative value basis.

Despite the recent rise in yields and increased inflation prospects, in recent weeks Federal Reserve Chairman Jerome Powell indicated the central bank would keep its easy money policies in place until substantial progress has been made toward its 2% average inflation target. In an effort to achieve this average target, the Fed will tolerate inflation above its target for a period of time to offset periods when inflation is below target, as it has been for nearly the last decade. Such progress has not yet been reflected in economic data, as the change in the PCE price index—the Fed’s preferred inflation gauge—for the 12 months ended January 2021 was 1.5%, according to the Bureau of Economic Analysis.

For investors, the bottom line seems clear: while the Fed is generally optimistic about the direction of the economy, monetary policy is unlikely to change in the near term.

Posted by

Share on facebook
Share on twitter
Share on linkedin
Related Posts
Defined Benefit

The Technology Revolution Catches Up to Commercial Real Estate

Bernie Bazile
Bernie Bazile explains "proptech" and what institutional investors need to know about it.
Defined Benefit

Momentum Keeps Private Equity Aloft

Gary Robertson
Callan's Gary Robertson analyzes private equity activity during the quarter.

The ‘Hows’ of Hiring Diverse Managers for Nonprofits

Brad Penter
When structuring a “prudent” portfolio nonprofit trustees can and should consider serving their mission by evaluating the benefits of hiring diver...
Defined Benefit

Pandemic Affects All Sectors of Real Estate and Real Assets

Munir Iman
Hotel and Retail are the most challenged sectors of private real estate, while Office faces uncertainty; Industrial remains the best performer.
Defined Benefit

Damn the Shorts and Margin Calls, Full Risk Ahead

Jim McKee
Emboldened by more injections of vaccines, central bank liquidity, and fiscal stimulus in 1Q21, investors’ risk appetites grew again.
Defined Benefit

The U.S. Economy, Now Open for Business

Jay Kloepfer
The U.S. economy may be on track for a truly eye-opening expansion, with initial projections pointing to growth rates of 9% or even higher for 2Q.
Defined Benefit

When the Passive Index Is an Active Decision

Weston Lewis
Because of differences in passive indices, investors should understand how the one they choose will affect benchmarking.
Defined Benefit

Capital Markets Assumptions and the Future

Greg Allen
CEO and Chief Research Officer Greg Allen analyzes how Callan's capital markets assumptions have compared to actual returns.
Defined Benefit

SEC Division of Examinations Issues ESG Risk Alert

Thomas Shingler
The Division issued the Risk Alert to 1) communicate its observations from past examinations and 2) address the Division’s areas of focus during upc...
Defined Benefit

Equities Off to a Strong Start; Inflation Fears Haunt Bonds

Kristin Bradbury
U.S. equities outpaced global stocks in 1Q21. The 10-year U.S. Treasury yield hit its highest intraday yield in 15 months during the quarter.