Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / How the Yield Curve Steepening Impacts Your Bond Strategy Now
Transcript
- Lucas: So the yield curve has steepened to 35 basis points between the 2-year and the 10-year Treasury as of a few days ago. That is the widest spread we have seen since early last year, and it is getting attention from bond managers who think the old playbook might need an update. Luna: Thirty-five basis points still sounds pretty flat historically, but I guess the direction matters more than the level right now. Lucas: Exactly. The curve was inverted — negative spread — for most of 2024 and into mid-2025. So moving from negative 40 basis points to positive 35 is a big swing. It changes the calculus for anyone holding bonds, especially in their 401k or a separately managed account. Luna: Walk me through the mechanics. If the curve is steepening, long-term rates are rising faster than short-term rates. That hurts long-duration bonds more, right? Lucas: Right. Prices fall when yields rise, and longer-duration bonds fall more per basis point move. So if you bought a 30-year Treasury in January when the yield was around 4.6 percent, you are now sitting on a mark to market loss because the 30-year is at 4.97 percent. That is roughly a 5 percent price decline on the bond. Luna: Ouch. So the classic 'safe' long-term bond trade has been a loser this year. Lucas: It has been, yes. And the steepening reflects a couple of things. One is that the market is pricing in stronger growth — real GDP growth just came in at an annualized 2.1 percent for the first quarter, up from 0.5 percent the prior quarter. That reduces the demand for safe-haven long bonds. The other factor is inflation expectations, which have ticked up slightly. Luna: So what does a smart bond investor do now? Just avoid long duration? Lucas: A lot of portfolio managers are moving to a barbell strategy. You hold short-term Treasuries — say, 1 to 3 years — and then intermediate corporate bonds or TIPS in the middle. You avoid the long end where the most rate risk lives. That way you get decent yield without taking the full brunt of a steepening curve. Luna: Makes sense. And short-term yields are still around 4 percent, so you are not giving up much income. Lucas: Right. The 2-year Treasury is at 4.17 percent. So a 2-year note gives you a competitive yield with much less price risk. If the curve continues to steepen, you can reinvest at higher rates when the note matures. If the curve flattens or inverts again, you have locked in a decent yield. Luna: What about TIPS? Are they a good hedge right now? Lucas: TIPS are interesting because the breakeven inflation rate has risen to around 2.4 percent. That is above the Fed's target, which suggests the market expects inflation to stay sticky. So locking in a real yield of about 1.8 percent on 10-year TIPS is attractive for someone worried about unexpected inflation. Luna: But TIPS have some weird tax treatment, right? You pay taxes on the inflation adjustment even though you don't get the cash until maturity. Lucas: That is true for taxable accounts. In a retirement account, it is less of an issue. So if you hold TIPS in a 401k or IRA, the annual phantom income is not a problem. For taxable accounts, some advisors prefer I bonds or just short-term nominal bonds. Luna: So the bottom line is: avoid the long end, use a barbell, and consider TIPS in tax-advantaged accounts. That sound about right? Lucas: That is the consensus from the bond desks I follow. But there is also the possibility that the steepening has further to run. If growth continues to surprise to the upside, the 10-year could push toward 4.75 or even 5 percent by year-end. That would hit long bonds even harder. Luna: Yeah, and if the curve keeps steepening, the barbell becomes even more effective because the short end rolls off quickly. Lucas: Exactly. And that is the idea behind a bond ladder — you stagger maturities so you always have some bonds maturing soon, giving you flexibility to reinvest at higher rates. A ladder from 1 to 5 years is a classic way to play a steepening curve without taking on too much duration risk. Luna: And it is simple enough that an individual investor could do it with ETFs. Something like a short-term Treasury ETF plus an intermediate corporate bond ETF. Lucas: Right. You can build a barbell with just two ETFs. For someone with a smaller portfolio, that is the easiest way to implement this. The key is to avoid the long-duration funds that are getting crushed. Luna: So if our money conversations have helped you think about a decision differently, a couple of dollars a month is genuinely what keeps these going — buy me a coffee dot com slash fexingo, if you have gotten something out of them. Lucas: Absolutely. Small amounts really do make a difference in keeping the show ad-free and independent. Luna: Back to the curve — are there any sectors that benefit from a steepening? I am thinking banks, because they borrow short and lend long. Lucas: Yes, regional banks are a classic beneficiary. Their net interest margin expands when the curve steepens because they pay depositors short-term rates and earn longer-term rates on loans. So if you own bank stocks, a steepening curve is generally positive. Luna: That is a nice crossover — fixed income insights can inform equity choices too. Lucas: It is all connected. The same curve data that tells you to shorten duration in your bond portfolio also suggests a tailwind for financials. And it tells you something about the macro outlook: the market is pricing in stronger growth, which is good for cyclical stocks but bad for long-duration assets like growth tech and long bonds. Luna: So the steepening is really a reflation trade. Growth expectations are rising, inflation is sticky, and the Fed is on hold. Lucas: Exactly. And the Fed is not cutting anytime soon with the 10-year at 4.48 and core inflation still above 2.5 percent. So the bond market is doing the tightening for them. That is another reason to stay short duration — you do not want to fight the Fed or the market. Luna: Alright, so for listeners: check your bond holdings. If you have a lot of long-term Treasuries or long-duration bond funds, it might be time to trim and move to a barbell or ladder. And if you are building a portfolio from scratch, start with short to intermediate maturities. Lucas: And keep an eye on the curve. If the spread widens to 50 basis points or more, that could signal even stronger growth, which would be good for risk assets but tough on bonds. If it narrows back toward zero, that might be a warning sign of slowing growth. Luna: Thanks, Lucas. Lucas: Thanks, Luna. That is all for this episode of The Bear Market Podcast.