MEAN REVERSION: BOND YIELD RELATIONSHIPS ARE LOOKING FAMILIAR, FINALLY BY JIM REBER Managing Director-ICBA Relations, The Baker Group I would like to make clear in the title of this column that we’re not talking about anything rude or unfriendly. In fact, you are about to learn just the opposite. It has been many a year since the U.S. bond market’s yield curve has been normally sloped. By “normal,” we mean that the differential in short and long yields (i.e., “2s to 10s”) is around 100 basis points (1%), which has been the average this century. However, a normal yield slope is like a heartbeat: it’s rare that we’re at the average. In fact, the last time the 10-year Treasury yield was 1% higher than the two-year yield was in November 2021. The painful 28-month window where the curve was upside down finally ended in September 2024, and we thought we were going to make a run at an even steeper curve this year. At the moment, we’re stuck in the plus-40 bps range. There is, in fact, a possibility that the Federal Open Market Committee (FOMC) hikes rates later in 2026, which could wipe out any slope altogether. NUMBERS HAVE IMPROVED So, we have some steepness, which fundamentally should help community banks’ net interest margins (NIMs). Using the 600+ banks that utilize The Baker Group for their interest rate risk modeling as a proxy, the industry is effectively insulated against rate shocks. The inverted yield curves of the recent past are evidence that positive slopes simply create pricing power across balance sheets. According to the FDIC, community bank NIMs improved by nearly 50 bps between March 2024 and March 2026 as the upside-down curve era receded into the merciful past. Another piece of this dynamic is that for the first time in four years, yields on Treasury securities across the maturity spectrum are higher than overnight rates. That too should create room for margin expansion. It’s intuitive that a two-year Treasury note should yield more than fed funds, but that wasn’t the case between 2023 and 2025. Portfolio managers now have an economic incentive to extend out on the curve and spread products — securities other than Treasuries — to provide a further yield boost. PLANETS AREN’T ALIGNED, YET But let’s not get ahead of ourselves. Yes, the curve has some modest slope, and yes, one can buy a two-year Treasury at a higher yield than sitting in fed funds. But we still aren’t at optimal levels for either. The 2-to-10 slope looks like it may be mired at its current levels until the bond market gets some clarity from the FOMC about its next steps. Also, under new Chairman Kevin Warsh, “clarity” may be hard to come by since he’s suggested that forward guidance may become a precious commodity. 8 The Community Banker
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