The Fed Keeps Raising Rates, But the Yield Curve is Getting Flatter

Wednesday, June 28, 2017 |

In November of last year, the effective Fed Funds rate was 0.40%. Currently, that rate stands at 1.25% or so after 3 hikes. Typically, when our clients hear of the Fed raising rates they think of negative returns for their bond portfolio (as interest rates rise, bond prices fall).

However, to date this has not happened as the interest rates on longer dated bonds have fallen (a similar trend is seen in the 30 Year Treasury):

Fed Funds vs. 10 Year

Source: Fred


This is reflected in bond returns as the Bloomberg Barclays US Aggregate Bond is up over 2.50% YTD. It also means the yield curve (longer interest rates minus shorter interest rates) has flattened:

Yield Curve
Source: The Daily Shot


This flattening has some possible implications:

  • Perhaps this is an indication of a weakening (though not recessionary) economy, which was also seen recently in the Economic Surprise Index turning negative.
    • Nte: The yield curve usually turns negative before a recession and we are still far away from that.
  • A flatter curve creates a weakening environment for bank earnings, which has been confirmed by banks underperformance this year.
  • Concluding there is a direct correlation one way or another between the Fed raising rates and how your bond portfolio will perform is futile.
 

Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.

The bond market is volatile and carries interest rate, inflation, liquidity and call risks. As interest rates rise, bond prices usually fall, and vice versa. Change in credit quality of the issuer may lead to default or lower security prices. Any bond sold or redeemed prior to maturity may be subject to loss. Treasury bonds (T-bonds) are long-term debt instruments with maturities of ten years or longer issued in minimum denominations of $1,000.

Citigroup's Economic Surprise Index is an economic indicator that measures how various economic data points are matching up to economic consensus expectations.