Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / What the Yield Curve Spread of 35 Basis Points Means Now
Transcript
- Lucas: The yield curve has been inverted for so long now, I think a lot of investors have stopped paying attention to it. But over the past few weeks, it's started moving in a direction we haven't seen in years — steepening. Luna: Yeah, and today specifically, the 10-year to 2-year spread hit 35 basis points. That's up from 31 basis points just a couple of days ago. So what's actually driving this? Lucas: Right, so let's start with the mechanics. The 10-year yield is at 4.48 percent, the 2-year at 4.17 percent. That's a positive spread of 35 basis points. For context, this curve was inverted by over a hundred basis points at its deepest in 2023. So we've come a long way. Luna: And the big question is whether this steepening is a good sign — meaning the economy is normalizing — or a warning that the Fed might have kept rates too high for too long. Lucas: Exactly. Historically, a steepening curve after a long inversion has often preceded a recession. But the nuance is in why it's steepening. If the long end is rising because growth expectations are improving, that's one thing. If the short end is falling because the market is pricing in rate cuts due to a slowdown, that's another. Luna: And right now, it seems like both are happening. The 10-year has crept up from around 4.3 percent a month ago, and the 2-year has actually fallen a bit from 4.2 percent. Lucas: Yeah, that's the key. The 2-year yield dropped partly because the market is more confident the Fed will cut rates later this year. The latest GDP data showed real growth at 2.1 percent annualized, which is solid but not booming. And the Fed's preferred inflation measures have been cooling. Luna: So the short end is coming down on rate-cut expectations. Meanwhile, the long end is being pushed up by something else — the term premium. Lucas: Exactly. The term premium is the extra compensation investors demand for holding longer-term bonds, beyond just expectations of future short-term rates. And it's been rising because of uncertainty around fiscal policy, debt issuance, and inflation persistence. The 30-year yield is now at 4.97 percent, flirting with 5 percent. Luna: That's a big psychological level. And it's interesting because a steepening driven by term premium is not the same as a steepening driven by growth optimism. Lucas: No, it's not. In a growth-driven steepening, equities tend to do well because the economy is strengthening. But a term-premium-driven steepening can actually be a headwind for risk assets, because higher long-term yields raise the discount rate on future cash flows. Luna: Which is one reason we've seen the Nasdaq still up over the past week, but with some volatility. The VIX is at 15.81, down over 10 percent in five days. So the equity market isn't panicking, but it's also not celebrating. Lucas: Right. And the Russell 2000, the small-cap index, was actually down half a percent over the past five days. Small caps are more sensitive to borrowing costs, so a steepening curve that pushes up long-term rates could hurt them more. Luna: So what should investors be watching now? Is the 35-basis-point spread a signal to change anything? Lucas: I think the most important thing is to watch whether the steepening continues and at what pace. If the 10-year breaks above 4.5 percent and stays there, that could start to weigh on rate-sensitive sectors like housing and utilities. Luna: And if the 2-year drops further as rate-cut expectations build, the curve could steepen even more quickly. Lucas: Yeah. One historical comparison that comes to mind is 2019. The curve had inverted in late 2018, then steepened sharply in 2019 as the Fed cut rates. That steepening happened alongside a strong stock market, but it was also a prelude to the recession that hit in 2020. Luna: So the steepening itself isn't necessarily a recession signal — it's the context around it. And right now, with the labor market still tight and GDP growing, it feels more like normalization than a warning. Lucas: I'd agree with that. But I'd also say that the term premium component is something to keep an eye on. If long-term yields keep rising because of fiscal concerns — the deficit, debt issuance — that could eventually crowd out private investment. Luna: And that's a slower-moving risk, not something that hits overnight. Lucas: Exactly. So for the average investor, the takeaway might be: don't ignore the bond market, but don't overreact to a single data point either. The curve steepening is worth watching, but it's not yet flashing red. Luna: Speaking of things worth paying attention to — and I know this is a bit of a sidebar — but Lucas, we've been doing this podcast for a while now, and it's always been ad-free. That's something we're proud of. Lucas: Yeah, absolutely. And the reason we can keep it that way is because of listeners who find enough value here to throw a few bucks our way. If today's episode helped you think about the yield curve in a new way, honestly, a coffee's worth is more than enough. Luna: Yeah, it's buy me a coffee dot com slash fexingo. No pressure, but it does make a difference. Lucas: And we're back to the curve. One other angle I want to touch on: what this steepening means for bond laddering strategies. Luna: Oh, good point. Because if you're building a ladder, a steeper curve gives you more incentive to go longer. Lucas: Right. With the 2-year at 4.17 percent and the 10-year at 4.48 percent, you're picking up about 31 basis points for extending by eight years. That's not a huge premium, but if the curve continues to steepen, locking in longer-term yields now could pay off. Luna: Especially if you think rates will fall in the next year or two. You'd be locking in current yields before they drop. Lucas: Exactly. But there's also the risk that if inflation reaccelerates, long-term yields could go higher, and you'd be stuck with lower than market yields. So it's a trade-off. Luna: That's where the term premium comes in again. If the term premium rises, long-term bonds become more volatile. Lucas: Yeah. So maybe the prudent move is to stay in the intermediate part of the curve — 5 to 7 years — where you get a decent yield without as much duration risk. Luna: And keep some powder dry in short-term instruments in case the curve shifts again. Lucas: Exactly. The curve is telling a story, but it's not a simple one. It's a combination of rate expectations, term premium, and global demand for safe assets. Parsing those components is the real skill. Luna: And that's why we keep coming back to it. Alright, I think we've squeezed a lot out of 35 basis points today. Lucas: We have. Next time, maybe we'll talk about what happens if the 30-year hits 5 percent. That's a whole other conversation. Luna: Let's do it. Thanks for listening, everyone.