Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Yield Curve Steepening Changes Bond Investing
Transcript
- Lucas: So the ten-year Treasury yield is sitting at four point four nine percent this morning, and the two-year is at four point two zero. That means the spread between them is about twenty-seven basis points — positive territory, but barely. Luna: Right, and that spread has been widening recently. A few months ago we were still flirting with an inverted curve, where short-term yields were higher than long-term ones. Lucas: Exactly. And the shift matters. For anyone holding bonds or even just sitting on cash in a money market fund, the shape of the yield curve is one of the most direct signals about where the economy and the Fed are headed. So today I want to focus on one specific angle: what a steepening curve — especially one driven by long-term yields rising faster than short-term yields — means for your bond portfolio. Luna: And for stocks too, because if long-term rates keep climbing, that changes the discount rate for future earnings. Lucas: Right. So let's start with the mechanics. A steepening curve can happen for two reasons. Either short-term rates fall — which would mean the Fed is cutting — or long-term rates rise because investors expect stronger growth or higher inflation. Right now, we're seeing the second scenario. The ten-year has climbed from around four point three percent in early June to four point four nine percent today. Meanwhile, the two-year has only moved from about four point zero five to four point two zero. Luna: So long-term rates are rising faster. That's the classic 'bear steepener' — bearish for bond prices, especially long-duration bonds. Lucas: Exactly. Duration is the key concept here. If you own a ten-year bond and yields rise by one percentage point, the price of that bond falls by roughly nine percent. A two-year bond falls by only about two percent. So in a bear steepener, longer-duration bonds take a bigger hit. Luna: And if you've been piling into long-term Treasury ETFs over the past year thinking rates would fall, you're feeling that pain right now. Lucas: Yeah, the twenty-plus year Treasury ETF, TLT, is down about six percent year to date. Meanwhile, short-term Treasury ETFs like SHV are basically flat. So the curve steepening is punishing the long end. Luna: What's driving the long end higher? Is it the new Fed chair, Kevin Warsh, signaling something? Lucas: Partly. Warsh has been pretty clear that he wants to normalize the balance sheet and keep inflation expectations anchored. But the bigger force might be the economy. Real GDP growth annualized came in at one point six percent for the first quarter, up from zero point five percent in the previous quarter. That's not booming, but it's a step up. And if growth picks up, the term premium — the extra compensation investors demand for holding long-term bonds — tends to rise. Luna: So the bond market is pricing in a stronger economy, but the Fed isn't cutting rates yet. The two-year is staying elevated because the Fed's policy rate is still at four point two five to four point five percent. Lucas: Right. And the market sees the Fed holding steady or maybe cutting once later this year, but not aggressively. So the short end is anchored by the Fed, while the long end is repricing growth and inflation expectations. That's the definition of a bear steepener. Luna: Okay, so what do you do with a bond portfolio in this environment? I feel like the classic advice is to shorten duration — stay in the two- to five-year part of the curve. Lucas: That's one approach. If you think the steepening has further to go, you want to avoid long-duration bonds because they'll keep falling in price. But there's another strategy that's gaining attention: the barbell. You put some money in very short-term bonds or cash — say, T-bills yielding around four percent — and some in longer-term bonds that you buy at a discount, hoping that if yields eventually fall, you capture price appreciation. Luna: So you're balancing yield today with future upside. But you have to be comfortable with volatility on the long end. Lucas: Exactly. And the barbell works best when the yield curve is steep because you get a decent yield on the short end while the long end offers a higher coupon than if the curve were flat. Right now, the thirty-year Treasury yields four point nine three percent. That's attractive for income investors who can tolerate price swings. Luna: Let's talk about stocks for a moment. If long-term rates keep rising, that raises the discount rate for equities, which compresses valuations. The Nasdaq is up two point four percent over the past five days, but it's been volatile. Do you see the steepening as a risk to the rally? Lucas: It depends on why rates are rising. If it's because growth is genuinely accelerating, then higher rates can coexist with higher earnings. But if it's because of inflation fears or a fiscal deficit blowout, that's more problematic. The ten-year yield going from four point three to four point five percent in two weeks — that's a pretty fast move. It's worth paying attention to. Luna: And the yield curve is still relatively flat by historical standards. Twenty-seven basis points is not steep. But the direction matters more than the level. Lucas: That's the key insight. The curve is steepening. And if that trend continues, it changes the optimal positioning for both bond and stock investors. I think the biggest takeaway is: don't assume the low-rate, low-spread environment of the past decade is coming back. The regime has shifted. Luna: And that shift is exactly the kind of thing our listeners tell us helps them make better decisions. You know, a couple of dollars a month is genuinely what keeps these shows going — buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, it really makes a difference. Keeps us independent and ad-free, so we can focus on what matters. Luna: Exactly. So back to the curve — if someone wants to position for further steepening, what's the simplest move? Lucas: I'd say tilt toward intermediate duration. Five-year Treasuries give you a yield around four point three percent with less price sensitivity than the ten-year. And if you want to take a view that the steepening will reverse, you could buy long-term bonds now while yields are high, but you need patience. Luna: Or just stay short and wait for clarity. Lucas: That's valid too. Cash is yielding four percent. There's no urgency to reach for yield if you're not sure. The main thing is to be intentional. Know your duration exposure. Don't just buy a bond fund because it paid well last year. Luna: Well said. So to wrap up: ten-year at four point four nine, curve steepening, barbell strategy, and beware of duration. Got it. Lucas: And check back with us tomorrow. With the VIX at sixteen point seven eight and the VVIX down over five percent in five days, we might be looking at a complacency signal worth digging into. Luna: Yeah, that's a good lead-in. See you then.