Lately, you must have heard of the term “yield curve” for US Treasury debt and wondered what this means in the investment process. We share our insights.
Why investors monitor a yield curve:
- Generally, a look at the yield curve is like a pulse check of the economy. Thus, on-going shifts in the yield curve are closely monitored.
- The yield curve is a line that plots the interest rates of US government bonds with different maturity dates at a specific point in time. When a yield curve exhibits an upward slope, it generally means that investment risks in longer-dated bonds are higher and thus would require more compensation than shorter-dated bonds.
How the yield curve is behaving:
- Recently, yield of the three-month US government bills rose above that of the 10-year US government bond for the first time since 20061. When the yield of a shorter-dated bond rises above that of a longer-dated bond, it is known as a yield curve inversion. This also means that investors perceive higher economic uncertainty in the near term.
What a yield curve inversion means:
- An inverted yield curve could suggest a recession is coming, but do not provide a timeline of when that will occur. More significantly, the inverted yield curve for the three-month and 10-year US government bonds is not a commonly referenced indicator of any recession.
- On the contrary, investors would traditionally watch the spread between the two-year and 10-year US government bonds as the most recognised indicator of any forthcoming US recession. Even if inversion happens, or the spread turns negative, there still is a time lag of about one year1, on average, before a recession occur.
Greater resilience in portfolios
With the US economy in the late cycle, market volatility is likely to persist. For investors holding a larger share of risk assets, it is worthwhile to be mindful of the need to build greater resilience in their portfolios. Gradual rotation from an aggressive portfolio to a more defensive portfolio2 could be an option.
As investors consider adding different types of bonds to their portfolios, they can also look at multi-asset strategies which provide exposure to both stocks and bonds for potential growth while managing risk.
1Source: FactSet, Federal Reserve, J.P. Morgan Asset Management (both charts); Standard & Poor’s (right).
Grey bars in the chart on the left represent recessions in the US while the blue line represents the spread between the two-year and 10-year US Treasury yields. Negative spread shown in the chart represents yield curve inversion where two-year yield is higher than 10-year US Treasury yield. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia 2Q 2019, page 49. Data reflect most recently available as of 31/03/2019.
2For illustrative purposes only, exact allocation of portfolio depends on each individual’s circumstances and market conditions.
Investment involves risk. Investors should consult professional advice before investing. The opinions and views expressed here are those held by the author as of the date of this publication, which are subject to change and are not to be taken as or construed as investment advice.