Changes in the U.S. Treasury yield curve
Source: U.S. Treasury Department, as of December 1, 2021.
- Markets have been volatile since Thanksgiving, driven in large part by the emergence of the omicron variant and hawkish comments from Fed Chair Powell, who testified to Congress this week that inflation was likely more than transitory.
- Investors now expect the Fed to hasten the end of its asset purchase program and potentially begin raising interest rates in the first half of 2022.
- Equity market volatility spiked this week while volatility in Treasury markets, which had already been present for several months, became exaggerated.
- To this end, changes in the yield curve have been notable as benchmark yields have declined despite skyrocketing inflation. As the chart shows, the 10-year Treasury yield has fallen 39 bps since its 2021 peak on March 31 while the 2-year Treasury yield has risen 40 bps.1 (A real-life example that Fed policy has the greatest impact on shorter-term rates.)
- The decline in longer-term rates has caused a level of confusion given many investors’ notion that inflation and interest rates are positively correlated. Amid today’s unprecedented and still-uncertain economic and business cycle, however, both the Fed and investors remain in uncharted territory and benchmark rates could move in either direction in the months ahead.
- This uncertainty only highlights fixed income investors’ ongoing conundrum. That is, core fixed income portfolios face significant downside risk if rates turn higher again but continue to offer little upside if they trade sideways or decline further. Against this backdrop, alternative sources of income that have the potential to generate attractive returns may remain at a premium.
