Yield-Curve Inversion Is Gone

On April 15th, I wrote about the inverted yield curve, suggesting that investors should avoid the 10-year Treasury. I warned about stocks too, which has been wrong. The yield curve has changed dramatically since then and is no longer inverted. Last night, the 2-year closed at a yield of 4.29%, and the 10-year closed at 4.45%. It's not particularly steep, but things have really changed, as two-year then was 4.90% and the 10-year was 4.52%.

So, short-term rates have declined substantially, while the 10-year Treasury has declined modestly. The 30-year Treasury Bond has actually increased in yield slightly. The Federal Reserve took action, cutting the target for Fed Funds by 0.50% in September and then by another 0.25% earlier this month. The decline in the 2-year, while less than the decline in Fed Funds, has been driven by this policy change.

Here is the yield curve as depicted on Bloomberg. Note that rates have increased a lot over the past month:

Of course, stocks are up a lot since 4/15, with the S&P 500, as measured by the big ETF SPY, is up 25.6% year-to-date and up 16.9% since mid-April. IWM, which measures Small-Caps, has gained 18.3% since then, outpacing the Large-Caps. The rate cuts helped, but perhaps there is more to the story, with the recent Presidential election.

I have been and remain bearish on stocks. I have written about an investment that I really like now, TIPS. I believe that longer-maturity Treasuries are risky, and that cash is pretty good right now. It remains to be seen what exactly President Trump will do, but we have an economy at risk of overheating it seems. Unemployment remains very low and budget deficits and debt at the federal level remain quite high.

The inverted yield curve has flipped to a modestly steep one. People betting on dramatically lower rates for longer-dated maturities have been wrong so far despite the actions by the FOMC. I think that stocks will not like it if interest rates rise more. Investors should watch for a potential break of 5% on the 10-year Treasury. We aren't there yet, but it could freak out investors if it happens. At 4.44%, it yields less than the Fed Funds target range.