Riding the Curve

During periods of economic growth, long-term government bond yields typically trade 1.5% - 3.0% above short-term bond yields as fixed income investors demand a higher return on their capital for longer duration investments. As the market cycle matures, while short-term yields generally continue to rise, long-term bond investors tend to accept a lower return (yield) with capital preservation becoming a primary focus. The yield curve flattens as a result. The chart below captures the difference between 2 and 10 year US government bond yields. The chart shows the yield curve flattening sharply in anticipation of periods of market weakness. When central banks begin cutting short term rates in reaction to market slowdowns, the yield curve steepens sharply and recessions follow shortly thereafter.


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