Bonds and curves: what are they for the economy?
At the most basic level, investors look at the bond yield curve to understand the economy. This can guide decisions about sectors or assets. Although more art than science, the curve can be flat or steep, with attention to changes.
Typically, it shows increasing returns over the long term due to higher risk. Longer-term loans involve more inflation risk. This is called a term premium. When short-term yields exceed long-term yields, it is an inverted curve. Investors monitor these indicators to understand the economic cycle and adjust their strategies.
Bears and Bulls in bonds?
Now a normal upward curve indicates a robust economy with long-term growth, without sharp increases in interest rates. In contrast, flattening or inversion may signal difficult times, such as a looming recession.
A "bear flattening" is when the yield curve rises sharply in the short term relative to the long term, suggesting concerns about tightening monetary policy; while a "bear steepening" is the opposite and may reflect inflationary fears.
On the other hand, a "bull steepening", which is a very rapid fall in short-term rates, can usually precede a rate reduction policy; while a "bull flattening" is when long-term rates fall much faster than short-term rates, which may indicate downward inflation expectations.
Curve inversion, particularly with short-term yields outperforming long-term yields, has historically preceded recession, but the time between inversion and recession can vary significantly. It is crucial for investors to observe the location of the shift in the curve to better understand its economic implications.
Chart 1: Different bond yield curves
Where will the next curve go?
Since March 2023, the yield curve has experienced notable fluctuations, from steepening to flattening. This seesawing reflects uncertainty about the Federal Reserve's policies and the economic expectations (graph 2).
Currently, the curve, with -42 basis points in the US and -52 in the Eurozone, suggests unease among investors. Recent forecasts from JP Morgan point to a yield of 3.80% for two- and ten-year bonds at the end of 2024, indicating a possible flattening of the curve. Despite this setback, some are still betting on a steeper curve, arguing its vital importance to economic performance.
Graph 2: U.S. 2-year yields; U.S. 10-year yields; U.S. US 2-year yields; US 10-year yields; US 10-year yield spread -2 years US 10-year yield spread -2 years
What opportunities do we see?
The inverted yield curve is a concern due to uncertainty about the Fed's actions. We expect a shift to an upward steepening, which could affect both bond and equity markets.
If you would like to obtain investment advice or identify opportunities in U.S. fixed income, our team of brokers will be happy to assist you and provide you with the information and advice you need.
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