Ivan Illan is Chief Investment Officer at AWAIM® and bestselling author of Success as a Financial Advisor For Dummies.
Back in January 2019, I published an article titled “Investing When Yield Curves Are Not So Shapely,” which discussed the economic challenges that emanate from a flat yield curve. Then, the spread between the 10-year versus 2-year U.S. Treasury was sitting a little above 0.20%.
By August 2019, the yield curve inverted slightly (-0.04%) for the first time since May ’07, just before the Great Financial Crisis in ’08-’09. As of this writing, the 10-year yields -0.49% less than the 2-year, which is an improvement from the more severe inversion of -1.08% in July ’23. Staying vigilant about the slope of yield curves globally is a primary data point for our firm’s Investment Committee consideration, playing a critical role in our capital markets expectations.
So what does a flattening yield curve mean for businesses and consumers?
The Cycle Of Concern
Economic uncertainty persists when businesses and consumers wonder if they will be able to maintain their spending as is. Changes in spending, whether corporate capital expenditures or households upgrading appliances, are based on confidence. This confidence could be sourced directly from their specific outlook on earnings. Households worry if their income is in jeopardy of decline or even elimination, while businesses worry whether such household concerns would begin to impact their sales. It’s a delicate balance and a self-reflexive cycle. Household worries lead to business worries, which lead to household worries.
With market interest rates at levels not seen since the Great Financial Crisis, it’s to be expected that businesses are more likely to be concerned about their ability to meet debt obligation payments. Every CFO knows that reducing payroll is one of the most effective ways to quickly adjust spending to meet an increased level of debt service payments. Some workers know this too, which fuels the cycle of concern.
The Flattening Yield Curve Paradox
Ultimately, a flattening of the yield curve at this point in the economic cycle is a healthy indication. As demand increases for short-term debt, prices increase, thereby contributing to falling rates on shorter maturities. Long-term debt yields increase as prices fall due to the selling associated with greater uncertainty over longer periods.
Both of these dynamics were explored in my 2019 article. These illustrate the normal and healthy functioning of the capital markets.
However, market participants rarely view this as healthy since it’s historically accompanied by high anxiety and panic selling across equity and debt assets. When yields rise on fixed-income instruments to nominal levels that visually compete with equity returns in the near term, investors believe the old “bird in the hand versus two in the bush” adage. Major asset class rotation from equities to fixed income, albeit a myopic pursuit, is a rational reaction.
For CFOs and business owners who are concerned about their debt service payments, it’s prudent to implement adjustments, whether it be a debt restructuring, hiring freeze or more extreme payroll reduction. For workers, minimizing unnecessary spending to bolster savings would offer greater peace of mind should conditions deteriorate rapidly.
For retirees living on fixed income, there’s an opportunity to rebalance your investment portfolio’s asset allocation to take advantage of the paradigm shift underway in the debt markets. But proceed carefully, as different parts of the yield curve present varying degrees of market value risk in the interim. Consult your financial advisor to ensure you’re prepared accordingly.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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