Yield curve inversion: Time to get back to your core

Yield curve inversion: Time to get back to your core

An inverted yield curve – when the 2-year US Treasury yield is higher than the 10-year US Treasury yield – may be a strong indicator of a pending slowdown in economic activity or a recession. The chart below shows that during 3-year periods that followed an inversion, the median returns of the Morningstar Intermediate Core Bond and Intermediate Core-Plus Bond categories were positive and outperformed those of other categories, including broad equities.

While an economic slowdown can lead to negative returns across many areas of the market, these two categories have a history of resilience and thus outperformance.

Category performance following yield curve inversions

Chart 1

Source: Morningstar, monthly data since January 1998.

What this means for investors:

While a yield curve inversion may frighten some investors, we think it suggests a favorable time to consider core-plus bond funds. Core-plus funds offer an attractive yield when compared with cash or government bonds, while still providing ballast to a portfolio through an allocation to higher-quality core bonds. And with access to “plus” sectors, a skilled, active core-plus manager can allocate to higher yielding areas of the bond market when it makes the most sense.

[2834007] 04/2023

Investing involves risk including the possible loss of principal. The investment capabilities described herein involve risks due, among other things, to the nature of the underlying investments. All examples herein are for illustrative purposes only and there can be no assurance that any particular investment objective will be realised or any investment strategy seeking to achieve such objective will be successful. Past performance is not a reliable indication of future performance.

Nothing presented should be construed as a recommendation to purchase or sell any security or follow any investment technique or strategy.

The views expressed represent the investment team’s assessment of the market environment as of April 2023, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

Market risk is the risk that all or a majority of the securities in a certain market – like the stock market or bond market – will decline in value because of factors such as adverse political or economic conditions, future expectations, investor confidence, or heavy institutional selling.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt. The Fund may also be subject to prepayment risk, the risk that the principal of a bond that is held by a portfolio will be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

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Charts shown throughout are for illustrative purposes only and not meant to predict actual results.

Chart is for illustrative purposes and is not representative of the performance of any specific investment.