Not only are we sceptical of the economic scenarios implied by the current pricing of the medium and long parts of the US yield curve respectively, but we believe they are even less likely to play out in combination. As a result, we expect the 5-30yr portion of the curve will steepen.
see video here
The US yield curve has flattened dramatically this year and parts of it have even inverted. An inverted 2-10yr yield curve is often watched as a predictor of a recession since it indicates that interest rates are close to peaking and will be lowered again as the economy slows. The 5-30yr part of the yield curve is less talked about, but it is still revealing. It reflects the market outlook for both the medium-term path of interest rates and also for longer dated bonds that are driven by structural factors, which go far beyond the scope of the current cycle.
As this week’s Chart Room shows, the 5-30 segment of the US curve is currently flat. We believe it’s unlikely to stay that way for long.
Yields on the five year are being driven higher by the Fed’s need to tighten policy amid historically high inflation. At the same time, signs are already emerging that surging inflation is weakening growth. If slowing growth starts to dominate the market narrative, the current path of interest rates implied by markets could look too aggressive, leading 5-year yields to stabilise, if not fall, as a result.
Meanwhile, the long end of the curve is indicating that once the hiking cycle is over, inflation will come under control and we will return to the disinflationary pattern that prevailed in the 2010s. However, a number of structural changes, including de-globalisation and greenflation, are likely to keep inflation elevated in the future.
Taken together, we think the combination of narratives priced by the 5-year and 30-year is unlikely to materialise. It implies that runaway inflation is a big enough danger that a record pace of tightening is necessary to rein it in with little chance of a Fed U-turn even if a recession comes. Yet at the same time, the current curve also assumes that in the long term this inflationary episode will be followed by a period of serene long-term price stability as forecast by the Fed.
In other words, the transitory inflation narrative is alive and well in the 5-30 curve. We see this as a contradiction that is likely to be resolved by the 5-30 steepening.
Important Information
This document is for Investment Professionals only and should not be relied on by private investors.
This document is provided for information purposes only and is intended only for the person or entity to which it is sent. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This document does not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities in any jurisdiction or country where such distribution or offer is not authorised or would be contrary to local laws or regulations. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity is not authorised to manage or distribute investment funds or products in, or to provide investment management or advisory services to persons resident in, mainland China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and analysis used in this documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. This material was created by Fidelity International.
Past performance is not a reliable indicator of future results.
This document may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organization that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
In Hong Kong, this document is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, Independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road., Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C Customer Service Number: 0800-00-9911#2 .
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.
ED22 - 071