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It is not uncommon for the yield curve to steepen as the economy exits a recession and transitions into expansion mode. After another Fed induced yield curve inversion in August of 2019, the economy dipped into a recession at the end of 2020. Certainly the pandemic shutdown contributed to the recession, but possibly the economy was headed in that direction anyway following the yield curve inversion.

With the yield curve spread at 123 basis points (10y Treasury minus 2y Treasury) and rising, this move higher in interest rates is a headwind for bond returns. The below chart highlights the return of a few bond ETFs since 9/30/2020 along with the return of the S&P 500 Index. With the yield curve steepening, and a faster rise in the long end of the yield curve, the longer maturity ETFs are generating the weakest returns.

The below table contains a broader range of fixed income investments and clearly, the increase in interest rates his having a broad negative return impact on investor bond returns. The weakest return is the PIMCO zero coupon bond ETF (ZROZ). Although interest rates/yields are low, those investments without any yield support are faring the worst as interest rates move higher.

If the economy begins to expand more rapidly as pent up demand gets satisfied, interest rates could continue to move higher. A chart making the rounds on social media over the weekend was one comparing commodities, specifically the gold to copper ratio, to the 10-year US Treasury yield. Below is a chart of a commodity index (DBC) that leads to a similar conclusion.

Since commodity prices have a tendency to lead interest rates, longer maturity interest rates could continue their move higher. At the beginning of 2020, the 10-year Treasury was near a 2% yield so that level is attainable. The current yield of 1.34% is near resistance as this is the level rates reached in the summer of 2016. Broadly though, it does seem the low in interest rates is behind for at least the near term.

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