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Financial Industry Insights from Advisors Asset Management
On March 02, 2015
AAM Viewpoints - Yield Curve and Where to Consider Investing
There has been much debate and discussion on the steepness of the yield curve, what it means and whether it will continue to flatten. I think it is a good discussion as the yield curve can be a valuable indicator of the overall health of the economy, but just as important is where on the curve an investor should consider putting their fixed income allocation.
Before we dive into a higher view of this question, the most important factor of where to invest rests with the particular needs of the investor. This is where the collaboration between an investor and their advisor is invaluable. Some of the factors that are specific to an individual’s particular needs are how close they are to retirement, their financial income needs, the amount of investable cash, and their risk tolerance to both credit and interest rate. The investor’s personal requirements and needs will impact the investment choices.
Now back to the yield curve. In the last year or so the yield curve, as defined by the difference between the yield on 5-year Treasury bond and the yield on 30-year Treasury bond, has tighten around 140 bps (basis points) from a 250 bps spread between the 5-year and 30-year to about 110 bps as it currently sits. There are several reasons debated for the move, one being the longer end of the maturity ranges are in high demand from foreign investors where the world sovereign markets, specifically Europe, have very low or negative yields.
The 10-year German Bund has been averaging 150 BPS less than the 10-year U.S. Treasury. This plays out similarly with other European nation’s bond yields. Generally speaking – everything being equal – which country’s debt would most investors rather own; the United States’ or another nation’s? This drives demand for the longer treasury bonds as they are attractive relative to their foreign counterparts. This demand for the longer maturities is compounded by the current lack of fear of inflation risk.
Most agree the Fed will raise rates either because the economy is doing better or because the Fed would prefer to be above zero to provided flexibility down the road to address future situations. For most, the debate is not whether the Fed will raise rates but when. Once the Fed raises rates, I believe it is safe to say that rates on shorter bonds yields will rise and bond values will go down. If the foreign and domestic demand remains strong on the longer maturities then relatively speaking the curve will flatten even further; there will be demand and pressure that will keep rates low on longer maturities.
From my view, the logical place not to put money is in the short end, but to consider investing in bonds in the mid-range; 5 to 10 years. An argument can be made to invest money on the long end, especially if the yield curve is flat or inverts, as that will indicate a recession is brewing (another subject, another time). I find it difficult suggesting investing in the very long end of the maturity scale given the very low net yields that are currently being paid for all the duration/ maturity risk involved. However I do understand the logic and why investors invest in the long end as part of an overall strategy.
This all said, remember the most important consideration is the individual investor’s personal financial situation. This will ultimately be the overriding factor on investment decisions.
CRN: 2015-0302-4655R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com
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