Treasury Yield Curve Theory: Can A Fed-Induced Inversion Be Bullish?

The US 5-Year yield surpassed both the 10 & 30-Year rates since the Fed initiated liftoff, while the 2/10 Treasury yield spread nearly inverted for the first time since 2019. The FOMC’s hawkish yield inverting projections (near-term rate estimates surpassing longer-run target) in its March meeting ignited the latest yield curve inverting action.

A Treasury yield curve inversion (negative 2/10 spread) has been a long-standing and reliable harbinger of looming economic turmoil, though timing is tricky, with the proceeding recessions being on average 17 months out from previous inversions. That being said, the present monetary & economic conditions are incomparable to anything in the past as we enter this unprecedented monetary tightening cycle. In fact, the real Treasury yield curve (adjusted for inflation) remains normal as the nominal curve inverts.

The Fed Drop’s Longer-Run Rate

The Fed Committee is now targeting a 2.8% Fed Funds rate for 2023 & 2024 (from 1.6% & 2.1% in December) to control over 4-decade high inflation, while reducing its longer-run Fed Funds projection by -10-bps to 2.4% (lowest in modern history). These new projections have been a primary catalyst of the Treasury market’s recent yield curve inversion (along with its illiquidity following the Fed’s conclusion of QE), while the down-trending long-term Fed Funds target unveils a far more systemic monetary shift.

The long-run Fed Funds Target is now 50-bps below the FOMC’s pre-pandemic outlook as our advancing economic structure illustrates an ability to handle easy money policies as digitalizing demands drive secular (innovation-back) growth into our new economy.

A small reduction in the long-term discount rate (even a fraction of a point) sizably drives up terminal values, a significant valuation determinate for high-growth stocks (longer-duration asset due to its cash-flows maturity being years out). Lower rate outlooks mean cheaper start-up/growth costs, which should open up the door to an endless stream of market-disrupting ventures, ensuring that the innovative curve continues to proliferate (illustrated by Moore’s Law).

Assuming the aggressive monetary tightening doesn’t send the US economy into a recession, this Fed-induced yield inversion might have bullish long-term implications for well best-positioned future-focused stocks, which are ostensibly looking at years of easier money policies that should fuel the commencing digital renaissance of the Roaring 20s.

The FOMC’s long-term rate cut generated a market proclivity for longer-duration securities like innovation stocks, benchmarked by Cathie Wood’s Ark Innovation ETF ARKK, as well as 10 to 30-Year Treasuries, which appear to be holding relatively more buoyant than its shorter-duration counterparts.

The spike in the Central Bank’s near-term rate has investors evacuating short-duration securities like energy XLE (though a lot of this sector’s recent inhibition is related to China’s new COVID restrictions) and fixed income assets with more abbreviated maturities (less than 5 years largely).

Now investors will look towards the upcoming Q1 earnings season to support their bullish/bearish investment thesis.

Zacks Names "Single Best Pick to Double"

From thousands of stocks, 5 Zacks experts each have chosen their favorite to skyrocket +100% or more in months to come. From those 5, Director of Research Sheraz Mian hand-picks one to have the most explosive upside of all.

It’s a little-known chemical company that’s up 65% over last year, yet still dirt cheap. With unrelenting demand, soaring 2022 earnings estimates, and $1.5 billion for repurchasing shares, retail investors could jump in at any time.

This company could rival or surpass other recent Zacks’ Stocks Set to Double like Boston Beer Company which shot up +143.0% in little more than 9 months and NVIDIA which boomed +175.9% in one year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.