Patience Pays: Leaning Into the Inverted Yield Curve

We have always maintained it is better to accept what the market has on offer than to stretch for returns. Thanks to the inverted yield curve and our flexible mandate, the current environment is making it easier than ever to be patient while we wait for fat pitches.

The actions of the Federal Reserve, combined with a resilient economy, have created an opportunity in fixed income that is ideal for our unconstrained mandate. We have always attempted to win not only on offense, through careful security selection, but also on defense, by tactically increasing cash when market conditions are unfavorable.

Thanks to the inverted yield curve, our defensive strategy has become part of our offensive playbook. Simply by taking what the market is giving at the short end of the curve, we are able to get paid above the risk-free rate while we wait for opportunities in higher-yielding, longer-maturity bonds. The pressure to stretch for yield — either by sacrificing quality or extending duration — is near an all-time low.

How Did We Get Here?

In the period since the Covid crisis, yield curves and interest rates have re-priced and materially changed the landscape for fixed income investors. At the start of the pandemic, the Federal Reserve aggressively cut interest rates to support the economy. Then, after keeping rates near zero for two years and engaging in quantitative easing, they were compelled to undertake a rapid hiking cycle to combat inflation pressures (which began with Covid-induced supply chain issues and were exacerbated by massive fiscal stimulus programs). Despite calls for/speculation around rate cuts for the past 15 months, the Fed has left its benchmark rate unchanged since June of 2023, which has led to the longest period of an inverted yield curve in over 30 years. The traditional assumption of the inverted yield curve preceding a recession has not yet come to fruition, and in fact, the curve may stay inverted for some time before that happens.