Fixed income investors will remember 2022–2024 as the longest and deepest yield curve inversion in modern history. After first inverting in July 2022, the yield curve didn’t revert back to “normal” until December 2024 — over a year after troughing at -1.09% (meaning the 2-year yield was higher than the 10-year yield by over 1%). Aggressive rate cut expectations by the Federal Reserve (Fed) and concerns about an economic slowdown that never materialized originally pushed longer-term yields down below shorter-maturity Treasury yields. However, with economic data coming in better than expected, inflationary pressures still above the Fed’s target, and with the prospects of increased Treasury supply expected to fill budget deficits over the next few years, longer-term Treasury yields have moved higher recently, further dis-inverting the curve. But while yield curves have recently steepened, they still aren’t steep by historical standards. Historically, the difference between the 2-year Treasury yield and the 10-year Treasury yield is close to 1%, albeit with a lot of variability. The 2Y/10Y spread is only at +0.33%.
The Treasury Yield Curve Could Further Steepen from Here
2Y/10Y Curve Spread
Source: LPL Research, Bloomberg 01/28/25
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.
In an inverted yield curve environment, absent a recession, many fixed income investors are better off investing in shorter-maturity fixed income instruments/strategies due to the higher yields at the front end of yield curves with little to no interest rate risk. However, with the recent dis-inversion and continued steepening of the yield curve, investors are now getting compensated for extending the maturity profile of their fixed income investments — somewhat.
Duration measures the interest rate sensitivity/risk of a bond/portfolio/strategy. All else being equal, the higher the duration of the fixed income instrument, the more interest rate risk it possesses. So, for example, when interest rates rise, the price of longer-duration strategies will decline more than a strategy with a shorter duration and vice versa. The recent steepening of the Treasury yield curve (and subsequent steepening in most other fixed income markets, including the investment-grade corporate credit market as well) is providing more yield, but that additional yield still carries higher duration risks. The compensation (yield) for owning the short-to-intermediate part of the corporate credit universe (out to seven years) still represents attractive risk/return with a yield per unit of duration ratio above one (meaning for each unit of “risk” investors are getting 1% of income/return) with the 1–5 year the sweet spot, in our opinion.
The Most “Bang for Your Buck” is Still in the Front End of Curves
Yield per Duration for the Bloomberg Corporate Index Maturity Buckets
Source: LPL Research, Bloomberg 01/28/25
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.
That said, the recent move higher in yields is providing attractive levels of income again with the highest total yields for the Bloomberg Corporate index since 2009. Income-oriented investors that can stomach additional volatility could perhaps extend the maturity profile of their fixed income holdings even further to take advantage of still high yields. However, despite the recent steepening of curves, we still think the best bang for your buck is in the 1–5-year parts of the corporate credit curve, with the 5–7-year part offering incremental value as well.
Lawrence Gillum | Chief Fixed Income Strategist
IMPORTANT DISCLOSURES
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