Note: A spread is the difference between the yield of a bond with one maturity compared with a bond of another maturity.
Sources: Vanguard, based on data as of March 1, 2022, from the U.S. Department of the Treasury, the Federal Reserve, and the National Bureau of Economic Research.
But Madziyire noted that yield curve inversions have typically happened further into an economic expansion when rates were already relatively high.
Patterson echoed the point: "Today we're talking about inversions when the federal funds rate remains very close to zero, certainly below anything most people would estimate to be a neutral rate," he said.²
The spread between 3-month and 10-year Treasuries may be a better indicator of an economic slowdown—and that spread isn't sending recessionary signals, Patterson said.
"Because the 3-month Treasury is much shorter than the 2-year, it is much more sensitive to Fed policy and reflective of current economic conditions, so its narrowing spread with the 10-year is generally a better indicator of potential recessions," he said. "The 3-month/10-year spread has actually widened in recent weeks, and the yield curve has steepened at the shorter end."
Mixed signals from a rising, flattening yield curve
Source: Vanguard, based on data from the U.S. Department of the Treasury.
What investors might do next
Madziyire said he and his team have been overweighting 10-year bonds and underweighting 2-year bonds. "Given the expected market reaction to the recent and upcoming Fed moves, we expect the rate at which the 2-year goes up to be faster than the rate at which the 10-year bond rises," he said.
He added that investors should continue to hold fixed income in their portfolios despite the short-term challenges associated with a rising rate environment. Short-duration bond portfolios will do relatively well in a diversified portfolio in such an environment because they are less sensitive to rising rates. But even when stock returns and bond returns decline in tandem, bonds provide diversification benefits, as the magnitude of losses in fixed income portfolios is often significantly less than that of stocks.
Rising interest rates can be good for bond investors and savers, as current and future income benefits from being reinvested at higher rates.
"Fixed income investors may feel some pain in the short term," Madziyire said. "But if you are a long-term investor, higher yields mean more income."