Does a Flattening Curve Mean Choppy Seas Ahead?

Some days along coast, the ocean is flat and glassy, with small waves curling up to the beach like gently folding flower petals.  The only thing that makes this picture more serene is a nice summer day, with 90 degree sunshine and a cold Corona Lite, fresh lime, and salt.  As we enter 2015, Fed watchers are eagerly chomping at the bit for the first overnight bank lending rate hike.  But in 2014, the yield on the 30-year treasury actually dropped yet again – a full 117 basis points.  On January 14th, 2015, the 30-year stunned Wall Street when the yield dropped below 2.4%.  This action on the far end of the yield curve sets the stage for an interesting scenario:  when the Fed does start raising rates, there is less distance for the short end of the curve to catch up to long end rates – and flatten the curve.  Will such flattening come this summer?  And if it does, will the clouds gather and ruin the mostly serene days the stock markets have seen since 2009?

In 1993, short-term rates remained around 3% for the entire calendar year, while the 30-year treasury yield fell 1%.  In 1994, short term rates rose above 5 ½%, and the 30 year rose 1%.  It took until the end of 1995 for the curve to flatten.  When did the next recession occur?  Not until 2001.  Investors enjoyed a booming decade of stock market returns during to 1990’s and it took years before the next economic slowdown began after the first Fed action was initiated in 1994.

Many investors fear Fed action which leads to a flat, glassy yield curve.  But beware lightening up on equites in your portfolio too early, as you might miss some great gains in the market.  Stay the course, and your patience may pay off enough to fund a late summer vacation at the beach with some Corona Lite, fresh lime and salt.

© 2015 Pawleys Investment Advisors, LLC. All rights reserved.

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