Tuesday 24 October 2023

US Bond Yield Inversion- High Interest for Short Duration, Lower Interest for Long Duration, What It Means for Investors

An intersting thing is happening in USA. 10 years bond yields are going down. In short, for 1 year bonds and lower, interest rates are at 5.6%. However, if you are borrowing for a longer duration, the interest rate is lower at 4.85%.

The different yield for each duration is widening and the fall in 10 year bond yields is somthing important for investors to consider.

What Does This Mean?

Simply, markets are pricing that yields will fall in 2 years time. This follows the Federal Reserve Dot plot. In the short run, there will be lots of pain for highly leveraged business models such as REITs, construction, commodities companies. However, in the long run, their financing cost are likely to go down with PnL improving. (*My view is in 2 years time, the 1 year bond and shorter will be at 3.5% (2% or 200 basis points reduction from now, Fed Dot plot indicates 3.75-4.00%)

Banks on the other hand, benefit quite the opposite and when rates start to go down, they will suffer from a net interest margin compression until interest rates start to stabilise on the low end. This is something for investors to start to prepare for. 

In 1.5 years to 2 years time, interest rates will fall and one has to consider will benefit or lose. To me, the fall in interest rates will definitely hurt banks. REITs are likely the beneficary to an interest rate drop.

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