The U.S. yield curve experienced a significant “bear flattening” in the final two months of the third quarter. A bear flattening move in the curve is characterized by increasing yields across the board, with the short-end rising faster than the long-end. As a reminder, when bond yields go up, bond prices go down. The 10-year Treasury yield now sits above 5%, levels we have not seen since 2007.
As mentioned in the Economy section, the Federal Reserve raised interest rates by 0.25% at the September meeting. Fed Chair Warsh cited inflationary pressures, increased geopolitical risks, and robust economic growth as the determining factors for the rate hike. Bond yields have risen for largely the same reasons. In addition, when U.S. Treasury yields rise, particularly on the long-end of the curve, it augments concern surrounding the U.S. fiscal deficit due to the resulting higher borrowing costs for the U.S. government. Higher government borrowing costs can lead to investor demand for even higher yields on long bonds.
While there is risk that bond yields will continue to rise, we are seeing attractive opportunities to put money to work in both the U.S. Treasury and corporate bond markets. Investment grade corporate bond spreads are still tight at 0.84%, but we view them as a good diversifier from government debt with a slightly higher expected return. Given the volatility in the yield curve, we are buying bonds that mature in the next one-to-five years in order to 1) manage duration risk and 2) take advantage of the attractive yields on the shorter end that have resulted from the recent flattening in the yield curve.
