Market Beat: The yield curve
April 19, 2018
One metric that investors should pay attention to is known as the yield curve.
The yield curve is a graphic representation of interest rates paid on U.S. Treasury bonds. Normally the rates paid on short-term bonds are quite a bit lower than the rates paid on longer term bonds. Short term T-bills typically pay the lowest rates and long term 30-year Treasury bonds pay the highest rates of return.
So, a normal yield curve will slope upwards as you look at the chart from left to right. What we're seeing today in this rising interest rate environment is a flattening of the yield curve. Right now the yield curve is the flattest that it has been in over 10 years, since 2007.
As of last Friday, April 13, the spread between the two year and the 10-year Treasury was less than one half of 1 percent or 46.6 basis points. One hundred basis points equals 1 percent. Basis points are also commonly referred to as "bips".
The two-year yield was 2.36 percent on Friday and the yield on the 10-year Treasury was at 2.83 percent. That means that a fixed income investor will get less than a half percent more by stretching their maturity out by eight years. Interest rates are still historically low, in a normal interest rate environment investors can expect to receive 4.5 percent to 5 percent from a 10-year U.S. Treasury bond.
It's likely that the Fed will continue to raise interest rates gradually over the next year or two as this tightening cycle continues. One likely scenario is that the yield curve will flatten even more. This will make the short-term bonds more attractive for investors.
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There have been times when the yield curve inverts. That means that the short term interest rates will become higher than long term interest rates. An inverted yield curve frequently precedes a period of economic recession. Bear markets in stocks are usually accompanied by a recession.
If the Fed tightens too much too quickly they could slow the economy down and we could see an inverted yield curve. Right now, the economy is doing well overall. The unemployment rate is low and we've seen consistent growth in the GDP or gross domestic product. Corporate earnings have been strong and should continue as earnings reporting season continues.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.