Compared to past periods, the yield curve inversion we are experiencing is quite benign. Therefore, there need not be profound concerns that an economic recession will automatically derive from this phenomenon.
After the Fed funds rate reaches its peak in the coming spring-summer timeframe, one can expect the shape of the yield curve to normalize and to become upwardly sloping once again.
Corporate bond yield spreads to Treasury yields may not suffer as a direct result of the inverted yield curve. In fact, overweighting corporate securities may be the right strategy in this difficult and tricky environment.
Finally, shortening portfolio duration may not always be the right strategy for maximizing cash portfolio returns with an inverted yield curve. When an inversion is relatively mild, one can expect that investing further out on the curve may provide higher return potential over shorter maturity targets.
We expect the current yield curve inversion to be mild, with opportunities for competitive returns for cash portfolios. Should the potential for a more severe yield curve inversion develop, we may adopt more defensive yield curve and sector selection strategies.
When the yields of short-term Treasury notes rose above that of long-term securities last December, the financial markets buzzed with a discussion of the phenomenon of an “inverted yield curve” and the likelihood that it forecasts an economic recession. An inverted yield curve can be damaging to bond investors as it often means lower income potential for bonds with higher interest rate risk. Particularly exposed are corporate cash portfolios with buy-and-hold strategies that derive most, if not all, of their returns from the income component.
More recent economic and market data seem to suggest that the curve inversion may be with us for quite some time. How to interpret this unusual yield curve phenomenon and its investment implications is no doubt a very timely subject. In this report, we set out to examine previous interest cycles where the yield curve inverted itself, in hopes of learning what to expect in short and long-term interest rate movements for the remainder of the year.
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