Steeping yield curve: What does it mean for investors

Steeping yield curve: What does it mean for investors

A few months ago, the financial media was flooded with the ‘inverted yield curve’, which is considered to be a precursor to a contraction in the economic activity. Now, a diametrically opposite phenomenon is occurring and we see that the yield curve is steepening. In India, we see the yield curve is at its steepest since 2010.

What is the yield curve

A yield curve simply plots the yield of the bond of different maturity on a graph. It gives you a sense of how long-term versus short-term bonds stand at various points in time. In normal circumstances, the yield curve slopes upward because investors want to be compensated with higher returns for assuming the added risk of investing in longer-term bonds. Rising bond yields reflect falling prices of bonds and vice versa.

The direction of the yield curve is typically measured by comparing the yields on 2- and 10-year issues. In general, the 10-year paper commands a higher yield. The yield, spread between the 10-year notes to 2-year debt, is at its highest since 2010 in India due to concerns regarding the government expanding record bond sales to meet its fiscal deficit. Some experts believe this to expand further. There are different reasons for this; however, the question is how an investor should approach in such a situation?

What should an investor do

The increase in this gap usually indicates that yields on long-term bonds are rising faster than yields on short-term bonds but, sometimes, it can mean that short-term bond yields are falling even as longer-term yields are rising. This may be happening due to RBI’s continuous key policy rate cuts.

Although we suggest you always to maintain a steady, long-term approach towards your bond portfolio based on specific objectives rather than technical matters, such as a shifting yield curve. However, short-term investors can potentially profit from shifts in the yield curve by purchasing by following a bullet strategy.

According to this strategy, you hold securities, targeting a single segment of the curve, with the bonds clustered around the portfolio’s duration target. The sweet spot at the moment is 3-3 part of the curve.