The simple answer: interest rates have mostly increased. The 10-year Treasury rate is the most commonly used benchmark for interest rates. As shown below, the 10-year Treasury bond yield was 2.23% in the middle of May, up from 1.84% at the end of October. On the short end of the yield curve, the 2-year Treasury rate was 1.28% in mid-May, up from .86% at the end of October. Since interest rates and bond prices are inversely related, bond investors have seen losses in their bond portfolios.
Even though short and long rates have generally increased since the election, the 2-year rate has yet to peak, while the 10-year rate has been declining since mid-March. What does this mean? Before we delve into that, we need to understand the relationship between short and long-term rates.
The relationship between yields of the same credit quality at different maturities is called the yield curve. The shape of the yield curve is often interpreted as a reflection of investor sentiment in both the bond and stock markets. Most of time, the yield curve slopes upward: long rates are higher than short rates. This is typically the case because bond investors making a long-term commitment take on more risk and need to be compensated for it by receiving higher interest rates.
Over the past 2 months, the yield curve has flattened somewhat, as shown below. What is especially noteworthy is that short rates have increased during this period, while long rates have decreased.
Short term interest rates are affected by Federal Reserve policy and market forces. The Fed increased the target Federal Funds rate by .25% in mid-December and again in mid-March (the Federal Funds rate is the rate banks charge each other for overnight lending), which is the principal reason why short rates rose. But Fed policy tends to have far less impact long term interest rates, which is why many market analysts view long-term interest rates as a purer reflection of long-term investor sentiment. Declining long term interest rates are generally considered an indication that investors have lowered their expectations for future interest rates. This is often associated with slower economic growth and inflation. Some commentators have taken this a step further and interpreted a flattening yield curve as a predictor of “re-pricing of risk”, meaning a potential correction in the stock market and other risky assets.
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