What the inverted yield curve means for your portfolio

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As investors digest another 0.75 percentage point rate hike by the Federal Reserve, government bonds could signal distress in the markets.

Ahead of news from the Fed, the policy yield on 2-year Treasuries climbed to 4.006% on Wednesday, the highest since October 2007, and the benchmark 10-year Treasury yield hit 3.561% after hitting an 11-year high this week .

When shorter-dated government bonds have higher yields than long-dated bonds, known as a yield curve inversion, it is seen as a warning sign of a future recession. And the closely watched spread between 2-year and 10-year Treasuries continues to be inverted.

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“Higher bond yields are bad news for the stock market and its investors,” said certified financial planner Paul Winter, owner of Five Seasons Financial Planning in Salt Lake City.

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Higher bond yields create more competition for funds that might otherwise go public, Winter said, and with higher Treasury yields used in the calculation to value stocks, analysts could reduce expected future cash flows.

Additionally, companies may find it less attractive to issue bonds to buy back stocks, a way for profitable companies to return cash to shareholders, Winter said.

How Federal Reserve rate hikes affect bond yields

Market interest rates and bond prices typically move in opposite directions, meaning higher interest rates cause bond values ​​to fall. There is also an inverse relationship between bond prices and yields, rising when bond values ​​fall.

Fed rate hikes have contributed somewhat to higher bond yields, Winter said, with mixed effects across the US Treasury yield curve.

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“The farther out you go on the yield curve and the more credit quality falls, the less impact Fed rate hikes have on interest rates,” he said.

That’s a big reason for the inverted yield curve this year, with 2-year yields rising more dramatically than 10- or 30-year yields, he said.

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It’s a good time to reconsider diversifying your portfolio to see if changes are needed, such as: B. Rebalancing assets to align with your risk tolerance, said Jon Ulin, a CFP and CEO of Ulin & Co. Wealth Management in Boca Raton, Fla.

On the bond side, the consultants monitor the so-called duration, which measures the sensitivity of bonds to changes in interest rates. Expressed in years, the duration takes into account the coupon, the time to maturity and the yield paid during the term.

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Above all, as always, investors need to remain disciplined and patient, especially if they believe interest rates will continue to rise.

Paul Winters

Owner of Five Seasons Financial Planning

While clients welcome higher bond yields, Ulin suggests keeping duration short and minimizing exposure to long-dated bonds when rates rise. “Duration risk can hurt your savings over the next year regardless of industry or credit quality,” he said.

Winter suggests tipping equity allocations toward “value and quality,” which typically trade for less than the asset’s value, versus growth stocks, which are expected to offer above-average returns. Value investors often look for undervalued companies that are expected to appreciate in value over time.

“Most importantly, as always, investors need to remain disciplined and patient, especially if they believe interest rates will continue to rise,” he added.

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