Last year, the yield curve inverted and sent chills down investors’ spines. Since then, we have indeed fallen into a recession, but one driven by the pandemic. Now, the yield curve is showing what else it can do. Currently, bear steepening has taken hold – which means that long term rates are pushing upward, driven by a tidal wave of monetary support. 

It is important to remember that bond prices and yields move in opposite directions. The amount of money a bondholder is due to receive is predetermined, so if one pays less to acquire a security, then the expected return — or yield — goes up. That means that when there’s a bullish move in bonds, yields go down. Conversely, when there’s a bearish shift, yields rise.

This type of shift happens when the Federal Reserve already has rates close to zero and pushes them a few notches lower while also flooding the system with liquidity  – and signals that it plans to keep short-term rates anchored for years to buoy growth. Hopes for another dose of fiscal stimulus to help U.S. output also sent long-term yields higher in September and early October — before President Donald Trump called off talks on a Congressional package. But, the stimulus could still happen, albeit a little later.

Future Wealth’s View

The yield curve has been a reliable predictor. We wrote about it in November 2019. The link is here – And now, much like then,  it is not wise to ignore the yield curve and expect things are going to get much rosier any time soon. For those who have not experienced the negative effects of higher inflation, it may be wise to look at what happened in the early 1980s. Due to high unemployment and massive government overspending, inflation started running rampant – peaking at 14.76%. And despite Paul Volker’s drastic measures, it took the entire decade to bring inflation down to 6%, still way above the 1.3% that the US is currently enjoying.

Inflation reduces the purchasing power of each unit of currency, which leads to increases in the prices of goods and services over time. A 1% inflation rate may make no material difference but a 10% inflation rate with incomes staying unchanged means people will get less for the same dollar and spend less which, in turn, means economic growth slows and we are back to square one with high unemployment.

Why is this important to consider? Every dollar of savings could be worth less in an inflationary environment which means the amount you thought will be sufficient to retire, may not be the right number – it may soon be time to think again.

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