An Inverted Humped Yield Curve
As a final note, while recent news headlines have focused on the inversion of the curve as well as short-term deflationary fears, few people have noted the rare inverted humped formation developing at the belly of the curve. This is a result of the uncertainty of the Fed’s medium-term policy.
This current yield curve formation resembles the term structure of the curve seen during three other time periods: October 1998, December 2000 and August 2006.
For a larger view, please click on the image above.
Each of those times were characterized by near-term uncertainty on future Fed policy action.
In 1998, the fear of contagion from the Asian financial crisis prompted the Central Bank to cut rates, but left the door open to further interest rates increases.
In December 2000, the Fed and markets were still weighing whether benchmark rates should decrease ahead of deflationary pressures at the time.
In August 2006, the Fed paused its tightening policy and left the door open for future rate increases or cuts based on upcoming macroeconomic data.
Where The Curve Steepens
Needless to say, today’s environment bears similarity to these past periods. Yet a key difference is that, in the current curve, key rates after the 10-year duration have steepened. The later action can be interpreted such that any cuts in short-term rates may be a temporary phenomenon, and inflation may show up on the midterm horizon.
It is a difficult time to forecast the yield curve’s next movements. Just a year ago, news headlines focused on rising rates and inflation worries. Instead, 2019 has been marked with lower yields and a marked inversion of the yield curve.
U.S. bond ETFs have performed incredibly well in this environment, especially long-term bond ETFs, as mentioned above.
At the same time, advisors can look at different strategies. For example, if an investor believes the curve will continue to shift lower, then core bond ETF positions and a satellite allocation to long-duration ETFs could be a good alternative to consider.
On the other hand, if the curve steepens, a core bond ETF position band with an overweight allocation to short-term ETFs should be an attractive option.
Contact Luis Guerra at [email protected]