Skip to main content
// //

The shape of the yield curve tells us a lot about investor expectations about the future. As of Sunday night, the odds the U.S. Federal Reserve raises the overnight rate was 97 per cent, according to the derivatives tied to the federal funds rate. In fact, that is the last rate hike the market has priced in at this point despite the Fed suggesting rates will be closer to 3.00 per cent by the end of 2018.

Since the Fed started raising interest rates in December, 2015, the yield curve has been flattening. The one exception was in the weeks after U.S. President Donald Trump's election when the markets were excited about Mr. Trump's growth and stimulus plan, which is still quite the mystery. A flattening curve in a combination of short-term interest rates moving up and longer-term interest rates falling suggests the rate hikes are likely to hurt growth and cool the economy.

We have said for years that interest rates would have difficulty normalizing. We have gone as far as to say that rates may stay low on average for decades to come. One reason we think so is that the amount of debt in the world today relative to past cycles is off the charts. Total debt-to-GDP (gross domestic product) levels globally are toxic. A 25-basis-point rate hike today has the impact of the 75-basis-point rate hike of past cycles due to all the debt.

For some perspective, the administration of former U.S. president Barack Obama borrowed about $9-trillion (U.S.), almost doubling the size of the federal debt as a percentage of the economy. Corporate balance sheets have been levering up, too, using the funds to buy back stock. A small rate hike today in dollar terms is more than double the hit it used to be. And on a percentage basis, going from zero rates to 1 per cent is much tougher on people and corporations that are only able to afford things because of the ultralow rates. We are seeing housing slow down, defaults on car loans have never been higher, and the middle class that has been stretching to keep up will be hurt the most.

When the yield curve flattens, it tells us that longer-term bond investors are worried about the economy in the future. Historically, an inverted yield curve is a precursor to a recession. We are not there yet, but the next few weeks will be very interesting to see if long bonds rise because investors are fearing inflation and more rate hikes to curb it, or if long bonds break below the 2016 yield curve trough in a sign that investors are more worried about the outlook for growth and fear that long bonds are portending a recession.

We learned a long time ago that bond investors were far smarter about the outlook for the economy than equity investors. The behaviour of the yield curve suggests we get even more cautious versus the benign exuberance we are seeing in equity markets. Perhaps last Friday's aggressive 2.5 per cent decline and reversal in the QQQ, which is the Nasdaq 100 exchange-traded fund, is a sign that equity investors are getting the message. We suggested about six months ago to buy longer-term bonds to protect your portfolios. If we see U.S. 10-year yields remain below 2.40 per cent by the end of the week, odds are good that we see them hit 1.80 per cent (where they were before Mr. Trump's election) before they hit 3.00 per cent as Wall Street consensus would make you believe.

The Street has been wrong on bonds for 15 years, we do not see what that would change now. My favourite way to play U.S. long bonds is with the TLT-Q (iShares long-term 20+ year Treasury bonds ETF).

Follow me on my new blog www.bermanscall.com or watch me at Berman's Call Monday's at 11am ET. Follow me on Twitter: @LarryBermanETF on Facebook: ETF Capital Management.

Report an error Editorial code of conduct
Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

If you would like to write a letter to the editor, please forward it to letters@globeandmail.com. Readers can also interact with The Globe on Facebook and Twitter .

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

  • Treat others as you wish to be treated
  • Criticize ideas, not people
  • Stay on topic
  • Avoid the use of toxic and offensive language
  • Flag bad behaviour

Comments that violate our community guidelines will be removed.

Read our community guidelines here

Discussion loading ...

Latest Videos

To view this site properly, enable cookies in your browser. Read our privacy policy to learn more.
How to enable cookies