Liz Looks at: The Flattening Curve

By: Liz Young Thomas · December 09, 2021 · Reading Time: 4 minutes

All I Want For Christmas is a Steeper Yield Curve

First things first, let’s define what I mean by a flatter or steeper yield curve. Treasury debt is issued at various maturities from one month to 30 years. Each of those maturities has an accompanying yield level that moves with market forces; with the shorter-dated maturities (two years or less) typically having a much lower yield than longer-dated maturities (10 years or more). If you plot all of those yields on a chart, the line slopes upward from left to right.

Right now, the slope of that line is too flat for my liking given where we are in the economic cycle, and for what I see as opportunities in 2022. A steepening curve, however, would cause certain parts of the equity market to face headwinds, so I want to lay out why steepening would be positive, and why I think it’s going to be under the tree this year.

Larger Spreads Bring More Cheer

We often look to the Treasury yield curve as an indicator of economic expectations. Specifically, the spread between 2-year yields and 10-year yields (“2s/10s”) can give us a read on what market participants think about future prospects for growth. The larger the spread, the more optimistic that picture is…usually.

In today’s environment, this indicator may mean something else. To put it in very simplified terms, the short end (2-year) is reflecting Fed rate expectations, and the long end (10-year) is reflecting inflation expectations. Problem is, markets seem to be much more uncertain about the path of inflation than about what the Fed is going to do, which has kept the 10-year yield low and driven the 2-year yield higher. We get public statements from the Fed about its plans. We don’t have a public spokesperson for inflation to give us a lens into its future.

I think the curve has it wrong. It’s no secret now that the Fed plans to tighten policy in the coming 12 months in the form of a faster taper and rate hikes. They plan to do this because inflation has remained high, and one can only surmise that they expect it to stay elevated into next year.

In all but one previous rate hike cycle, the 2s/10s spread was larger than this before hiking began. As it should be, given the current strength of the economy and much improved labor market.

Doesn’t Have to be a Scrooge for Stocks

If I get my wish and the yield curve steepens, particularly because the 10-year portion rises considerably from here (currently at 1.52%), won’t that be bad for stocks? Some of them, sure. All of them, no.

Up until this point, the low yield on the 10-year Treasury has lured growth investors into a false sense of valuation security. We’re going to get our last inflation reading of the year on Friday and we’ll hear from the Fed on Dec 15. If the inflation data is as hot as expected (estimated to be 6.8% y/y for Nov), and the Fed sends a message about an accelerated taper and more hawkish rate stance, the curve should theoretically steepen and growth stocks should theoretically see a headwind. On the flip side, the economically sensitive areas such as Energy, Financials, Industrials, and you guessed it…small-caps…should see a tailwind.

I’m not anti-growth or anti-technology, in fact I’m pro-both. But I’m also pro-economic strength and pro-fundamentals. A strong economy and strong corporate fundamentals puts markets in a position to not only withstand a steeper curve, but grind higher while it steepens.


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