Key takeaways
Two-year Treasury yields recently fell below 10-year Treasury yields, signaling an end to the so-called inverted yield curve.
A yield inversion continues between 3-month and 10-year Treasuries, but with a narrowing differential.
While an inverted yield curve is viewed by some market observers as a harbinger of recession, since 2022 – when the yield curve for Treasuries inverted – the economy continued expanding.
In early September 2024, 2-year Treasury yields dropped below those of 10-year Treasuries, reestablishing a normal yield curve in that portion of the yield curve spectrum. The move occurred in anticipation of Federal Reserve (Fed) interest rate cuts, which came later in the month. However, the inversion between 3-month and10-year Treasury yields persists.1 An inverted yield curve describes a bond market dynamic in which shorter-term U.S. Treasury yields exceeded those of longer-term Treasuries.1
“People who don’t intend to keep money in cash over the long term should implement a plan to start migrating money out of cash and into longer-term bonds,” says Rob Haworth, senior investment strategy director for U.S. Bank Asset Management.
Notably, after the Fed’s September rate cut, yields on 2-year and 10-year Treasuries trended higher, while those of 3-month Treasuries declined. “The fed funds target rate has its most direct impact on the short end of the yield curve,” says Rob Haworth, senior investment strategy director at U.S. Bank Asset Management. “Longer term rates move more independently, so they may fluctuate up-and-down.”
The yield curve compares current interest rates, or yields, on debt securities across various maturities. Investors typically demand higher yields when investing their money for longer periods of time. This is referred to as a normal, upward sloping yield curve, as depicted below, reflecting the actual Treasury yield curve at the end of 2021.1
At rare times, the yield curve inverts, which means that yields on some shorter-term securities are higher than those for some longer-term securities. This occurred in 2022 and only recently did 2-year Treasury yields drop below those of 10-year Treasuries.
Particularly since the Fed’s September 0.50% interest rate cut, the 3-month/10-year inversion has narrowed. “If the Fed cuts rates by another 0.50%, that would come close to returning to a normal yield curve,” says Haworth.
The recent inversion between the two-year and 10-year Treasury, often considered a signal of a pending recession, was the longest period in history for an inverted curve.2 Yet no recession occurred. “While rising yields created economic headwinds, high accumulated savings, labor market growth and wage growth all helped offset the higher rate environment,” says Haworth. Notably, the U.S. economy grew at annualized rates of 1.6% in 2024’s first quarter and 3.0% in the second quarter.3
As yields on short-term securities decline, Haworth recommends investors consider longer-term bonds, with yields that are far more attractive today than they were at the start of 2022. “People who don’t intend to keep money in cash over the long term should implement a plan to start migrating money out of cash and into longer-term bonds.” For investors holding a diversified portfolio of equities, fixed income and real assets, Haworth says there’s an opportunity to reduce portfolio risk. “When interest rates were very low, many investors were more aggressive in order to reach their return objectives. Today, with bonds generating higher income than before, some investors may consider trimming equity positions and adding to fixed income holdings as a way to achieve goals with reduced risk.”
Haworth also notes there’s increasingly positive investor sentiment for non-Treasury segments of the market. With certain non-taxable portfolios, this includes non-government agency issued residential mortgage-backed securities, while managing total portfolio duration using longer-maturity U.S. Treasuries. Certain tax-aware portfolios can benefit from municipal bonds, including some longer-duration and high-yield municipal securities. Trust portfolios may benefit from reinsurance as a way of capturing differentiated cash flow with low correlation to other portfolio factors such as economic trends.
Check-in with your wealth planning professional to make sure you’re comfortable with your current mix of investments and that your portfolio’s asset allocations remain consistent with your goals, risk appetite and time horizon.
A yield curve plots the interest rates paid by bonds of comparable credit quality across various maturities. A Treasury yield curve provides a comparison of government-issued bond yields of different maturities. A typical yield curve will trace current yields for Treasury debt securities with yields of three months, two years, five years, ten years and 30 years.
Typically, investors expect to earn higher yields from bonds with longer maturities. In a normal environment, the yield curve will be upward sloping. For instance, that means the yield on shorter-term bonds will be lower than the yield on longer-term bonds. However, in certain circumstances, the yield curve inverts and slopes downward. In this environment, yields on short-term securities exceed those of long-term securities. While some market observers view an inverted yield curves as harbinger of recession, that hasn’t happened in the current cycle since the yield curve first inverted back in 2022.
The yield on a U.S. Treasury security, its effective interest rate, indicates the income that will be generated for an investor when purchasing a bond. For instance, when investing $10,000 in a 10-year U.S. Treasury note with a 4% yield, the investor will be paid income of $400 per year. Bond yields are locked in when an investor purchases a specific security, but yields paid by newly-issued U.S. Treasury securities will vary on a day-to-day basis.
The Federal Reserve has started easing monetary policy by cutting interest rates. Does this mean the threat of a recession has receded?
A fresh look at managing your cash and investments in today’s changing interest rate environment can help support your pursuit of the goals that matter most to you.
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