21 February 2021
Source: Bloomberg & Momentum Global Investment Management
What this chart shows The chart shows the difference between the 10-year and 2-year US Treasury bond yields through time. A positive difference means 10-year bonds have a higher yield than the 2-year bonds, as is typically expected as there are greater uncertainties with respect to inflation and interest rates associated with longer maturity bonds and investors demand compensation (through higher yields) for this, and for locking up their capital for longer. This is known as an upward sloping yield curve, where the curve plots the relationship between time to maturity and yield.
An increasingly positive line here reflects a steepening yield curve, whilst a decreasing positive spread reflects a flattening yield curve. If the difference becomes negative, this means the yield curve has inverted between these two maturities, such that the 2-year bond yield is higher than the 10-year yield, meaning investors expect interest rates to decrease. Such a move is often used as an indicator of an upcoming recession, whilst a steepening curve is more indicative of reflationary expectations, itself reflective of future growth. The US yield curve has steepened of late and is currently at its steepest level in four years. Why this chart is relevant Rising yields mean falling bond prices and negative capital returns. A steepening yield curve indicates investors expect economic expansion, a rise in inflation expectations and as a result interest rates to increase. A lot of the recent steepening of the yield curve is likely due to expectations of a large fiscal stimulus package out of the US which has pushed up inflation expectations, along with the coronavirus vaccine deployment boosting the outlook for economic growth.
The Fed has continued its extensive monthly purchase of bonds which has also served to keep shorter term yields low. It is important to note the Fed has recently announced it will tolerate inflation above its target of 2% for a time such that inflation averages the target level over time. This might prevent them from raising rates unless inflation becomes sustained or more entrenched. Furthermore, an abrupt end to monthly asset purchases risks a taper tantrum episode as was experienced in 2013 which saw bond yields spike and steep losses for bond investors. They will be determined not to cause a similar reaction again.
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