Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the Yield Curve Steepening Is a Warning Signal
Transcript
- Lucas: So the yield curve just did something that has my attention. As of July second, the spread between the ten-year Treasury and the two-year Treasury hit 35 basis points. That's up from 31 basis points a week earlier. And it's the steepest the curve has been since early 2023. Luna: Wait — the curve steepening is a good thing, right? I thought an inverted curve was the recession warning. Lucas: That's the common take, and you're right that inversion is the classic recession signal. But here's the nuance: the curve steepening after inversion can be just as ominous. We saw this play out in 2019, and again in 2007. The inversion tells you the market expects a slowdown. The steepening tells you the market expects the Fed to cut rates aggressively to fight that slowdown — or that inflation expectations are rising again. Luna: So the steepening itself isn't the all-clear. It's more like the market pricing in a specific scenario. Lucas: Exactly. And right now, the ten-year is at 4.48 percent, the two-year at 4.17 percent. That 35-basis-point spread is still small by historical standards — the average spread over the last 20 years is closer to 100 basis points. But the direction matters. This steepening is accelerating. Luna: And what does that mean for the average investor? I'm thinking about the tech-heavy NASDAQ at 25,833, up 2.1 percent in the last five days. The VIX at 15.81 feels calm. Lucas: Right — the VIX is down 8.5 percent over the same period. So you have this apparent tranquillity in equity volatility, while the bond market is sending a more complicated signal. For dip buyers, this is a tricky environment. A steepening curve can be a headwind for growth stocks because it raises the discount rate on distant future cash flows. At the same time, it's a tailwind for banks, because they borrow short and lend long. So the market is rewarding some sectors and punishing others. Luna: Banks have been rallying, haven't they? I've seen JPMorgan and Bank of America up on the steepening trade. Lucas: They have. And that's a rational response. But the broader question is whether this steepening is driven by real growth expectations or by inflation fears. If the market believes the Fed will have to keep rates higher for longer to fight inflation, then the steepening is a warning. If it's a genuine growth pickup, then it's a positive. Luna: What do the data say? We just had GDP numbers — real GDP growth annualized at 2.1 percent for the first quarter of 2026, up from 0.5 percent in the previous quarter. That's a decent pickup. Lucas: It is. And the nominal GDP is over 31.8 trillion dollars. So the economy is growing. But the ten-year yield rising faster than the two-year suggests that the market is pricing in higher term premiums — compensation for uncertainty about inflation and fiscal policy. I'd watch the 30-year bond. It's at 4.97 percent, creeping toward 5 percent. That's a level we haven't sustained since before the financial crisis. Luna: If the 30-year breaks 5 percent, that's going to rattle a lot of portfolios. Pensions, insurance companies, anyone holding long duration. Lucas: Absolutely. And it feeds back into equity valuations. The S&P 500 is at 7,483, up 1.8 percent in five days. That looks resilient. But if bond yields keep climbing, the equity risk premium gets squeezed. Investors start asking: why take equity risk for a 200-basis-point premium over a risk-free 4.5 percent? Luna: So the old 'TINA' — there is no alternative — argument is fading. Lucas: It's fading fast. And that's why I think the yield curve steepening right now is probably more warning than all-clear. Look at history: in 2007, the curve inverted in early 2007, steepened through late 2007, and the recession started in December 2007. In 2019, it inverted in August, steepened into early 2020, and then COVID hit. Not every steepening leads to recession, but it's worth paying attention to the pattern. Luna: And for listeners who are looking at this as a buying opportunity — what do you tell them? Lucas: I'd say be selective. If you're going to buy the dip, focus on sectors that benefit from steepening: financials, value stocks, short-duration assets. Be cautious with long-duration growth and tech, especially the names that are priced for perfection. And keep some dry powder — because if the curve steepens further, volatility may not stay at 15.81 for long. Luna: Honestly, this is one of those episodes where I feel like I'm learning as much as our listeners. And that's because we get to dive into topics like this without any ads or sponsors. If today's conversation was worth a coffee to you, buy me a coffee dot com slash fexingo. It's the smallest ask, and it keeps the show independent. Lucas: Yeah, absolutely. No pressure, but listener support is what keeps us ad-free. So if you find value, that's the link. And now, back to the bond market — what about the 2-year yield specifically? It's at 4.17 percent, actually up a bit from 4.14. That's interesting because the 2-year is more sensitive to Fed policy expectations. Luna: Right. So the 2-year rising alongside the 10-year suggests the market doesn't expect aggressive rate cuts anytime soon. That's consistent with a 'higher for longer' narrative. Lucas: Exactly. If the steepening were driven purely by rate cut expectations, you'd see the 2-year falling. Instead, both are rising, but the 10-year is rising faster. That's the term premium story. It's about uncertainty, not about a rosy growth outlook. Luna: And that uncertainty includes fiscal policy, right? The deficit, the debt ceiling debates, all of that. Lucas: Big time. The Treasury is issuing a lot of debt. The 30-year at 4.97 percent is partly a supply story. Investors demand a higher yield to absorb all that issuance. So the steepening has a technical component as well. It's not just macro. Luna: So for someone building a portfolio today, what's the play? Lucas: I think a barbell approach makes sense. On one side, short-duration bonds or floating rate notes to capture current yields without duration risk. On the other, select value equities and financials that benefit from steepening. And then a small allocation to commodities or real assets as an inflation hedge. Avoid being overweight long-duration anything. Luna: And for the dip buyers who are eyeing the NASDAQ? Lucas: I'd be very selective. The NASDAQ is up 2.1 percent in five days, but the yield curve steepening is a headwind for high-multiple tech stocks. Look at the names that have strong free cash flow and reasonable valuations — not the ones trading at 50 times earnings with no profits. The market is going to punish the latter if yields keep rising. Luna: So the 'buy the dip' mantra needs a qualifier: buy the dip in the right sectors. Lucas: Exactly. Blindly buying the NASDAQ because it's down 10 percent from its high is not a strategy. You need to understand what's driving the macro environment. Right now, the macro is saying: be careful with duration, both in bonds and equities. Luna: And the VIX at 15.81 — does that signal complacency? Lucas: It could. The VIX is 8.5 percent lower in five days, yet the bond market is sending a warning. That divergence is worth noting. Usually, the VIX and bond volatility move together. When they diverge, one of them is wrong. My bet is that the VIX is too low. Luna: So there's a potential volatility shock ahead? Lucas: Possibly. If the 10-year breaks above 4.5 percent — it's at 4.48 now — and the 30-year tests 5 percent, I think we could see a rotation out of growth stocks that spikes the VIX back into the low 20s. That would be a painful week for anyone who bought the dip without understanding the bond market. Luna: Painful but maybe a buying opportunity itself. Lucas: Right — if you have dry powder. That's the key. You can't buy the dip if you're already fully invested. So the message today is: don't let the low VIX and the steepening curve lull you into a false sense of security. Be prepared. Luna: Alright, so to wrap up: the yield curve is steepening, it's a warning, not an all-clear. Be selective, keep some cash, and watch the 30-year. Lucas: That's the takeaway. Thanks for joining us on The Bear Market Podcast. We'll be back tomorrow with another angle.