HIGH ANXIETY PORTFOLIO MANAGEMENT Yield Curve Shape Reflects Bond Market’s Mood BY JIM REBER, CPA, CFA PRESIDENT AND CEO, ICBA SECURITIES Let’s start this month’s column with a dose of banality: Be careful what you wish for. For at least four years, all manner of bond market participants — including analysts, consultants, pundits and, last but not least, investors — have been predicting and hoping for a normally sloped yield curve. Though the longest-on-record inversion finally corrected itself last September when the Fed first cut rates, we did not see a positive slope of even 50 basis points (0.5%) until May. (Trivia fans: The average difference between 2s and 10s was a nice, neat 100 basis points for the past 15 years.) Most community bankers I’ve spoken with this year have been hoping for a steeper curve. Even though the interest rate risk of most banks is well insulated against relatively small rate shocks, the feeling is that a more normal curve shape would help loan officers and liquidity managers to price relative risk. Aligned with this is the notion that we’re in a secular falling rate environment, as evidenced by Fed funds futures that have been projecting between one and four rate cuts by the end of 2025. And now? Wholly unrelated to economic factors are trade policy and fiscal issues that drive interest rates. The Fed may stay on the sidelines for a good long while. And the yield curve? It’s gotten some slope all right — compliments of a “bear steepener.” What It Looks Like Bear steepeners are interest rate maneuvers in which rates rise and longer tenors increase more than shorter ones. They are relatively rare, as most of the time the curve steepens, it’s the result of anticipated or actual rate cuts by the Fed. Why is this? First, I should repeat myself (hackneyed, again) that all rates have trended lower since the 1980s, the last three years notwithstanding. Also, think about what the Fed is trying to accomplish when it employs rate hikes: It is trying to slow down the economy and/or stamp out inflation. Both of those are reasons for the curve to flatten. And now? Long-term investors (say five years and more) are highly concerned about inflation reigniting and the projections of escalating national debt. The Fed, for its part, is having to take a wait-and-see approach, so it’s wholly unclear when or if it will make a change to monetary policy. The result is the 2025 bear steepener, in which the longest rates are hitting multiyear highs. 2013 Hissy Fit In the lexicon of veteran portfolio managers and community bankers is the “Taper Tantrum.” This occurred in 2013, when the U.S. economy was still working through the Great Recession. The Fed, then chaired by Ben Bernanke, was in the middle of 6
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