Curbing Client Concerns About the Yield CurveAdvice to the Advisor
The Fed has really focused on the yield curve, a commentator opined on CNBC’s Trading Nation. “While a flat yield by itself isn’t bad, when it inverts and the yield curve for the 10-year yield starts to yield less than the three-month yield, that’s when the red flags go up for a potential recession.”
“This is currently the longest time since the yield curve inverted,” Paul Hickey pointed out in that CNBC interview in March. “The bond market has not seen an inverted curve in 2,767 trading days, the longest streak in history. This stretch beat the last record of 2,265 trading days that ended in 1998.” Just one example of the many media pieces designed to cause client concern over rising interest rates, this article certainly invites discussion on the part of investment advisors.
As Sheaff Brock Managing Director David Gilreath emphasizes in April’s Knowledge Builder webinar, rates do not appear to be heading towards an “inverted yield curve” (in which short term rates are higher than long-term rates, a situation that historically has come before a recession). In fact, according to Strategas Research, rates “should still be upward sloping by year-end.”
“In April,” reported the Federal Reserve Bank of Cleveland, “short rates continued to rise, but long rates could not quite keep pace, so the yield curve moved higher and continued to get flatter.” In terms of predicting whether or not the economy will be in recession in the future, the Federal Reserve Bank concludes: “So the yield curve is optimistic about the recovery continuing, even if it is somewhat pessimistic with regard to the pace of growth over the next year.”
Is the yield curve just more mumbo-jumbo, clients may ask, or has it proven to be a valid prognostication tool? “This observation holds true both over time and across countries,” says Joseph Haubrich of the Federal Reserve Bank of Cleveland, referring to the rule that negative spreads precede negative growth while positive spreads precede positive growth. Still, Haubrich observes, we’re in a different era today. In the “old days,” he observes, fears of inflation meant the yield curve would be steep because investors demanded high rates to protect themselves against inflation. “Now, with a credible Fed and a low risk premium, an inversion only signals moderately high short rates, and thus less risk of recession.”
Understood from an investor’s vantage point, “Interest rate movements are essentially the bond market’s way of signaling how investors feel about their future,” as Kate Stalter writes in U.S. News. “When the investment outlook is good, interest rates tend to move higher to compensate investors who could earn even higher returns in risky assets like stocks.”
The Fed has focused on the yield curve, but interest rate changes represent just one of several economic indicators investors can use in an effort to better understand the economy and make appropriate adjustments to their portfolios.