What does the chart show?

The chart shows the US Treasury yield curve (red line) and the US breakeven yield curve (blue line) as at 4 May 2022. The first compares the yields available on similar US treasury bonds with different maturities. Its “normal” shape is upward sloping, with higher yields on bonds with longer maturities, reflecting investors being compensated for tying up their capital for longer and being more at risk of changes in inflation and interest rates levels. The breakeven yields, instead, indicate the maximum level to which bond yields can move to in the next year before investors start experiencing a net negative total return. The higher the breakeven yield compared to the bond yield, the more the investor can withstand a yield rally.

Why is this important?

With the Fed tightening monetary policy and increasing policy rates, the front end of the curve has repriced substantially, moving from a 0.2% yield on a 2-year bond only 12 months ago, to the current value of around 2.8%. The long end has also come up, though by a lesser extent, with the 10-year yield having come up from 1.6% to 3% over the same period. Bond investors have experienced very poor total returns over the period, -4.3% and -9.2% respectively for the 2-year and 10-year maturities, as rising yields (or falling bond prices) overwhelmed the lower starting yields.

However today the situation is substantially different. The risk of bond yields rising is still very high, but starting yields are a lot higher than a year ago, which provides a good buffer for bond investors. For instance, an investor in the 2-year US treasury bond would need to see yields going up by about a further 1.9% over the next year before eroding all the gains made on the income and roll-down side. Long-term investors have a lower buffer, because of the longer duration (and hence interest rates sensitivity) of their income streams, but right now the longer end of the yield curve seems to be less at risk of big swings.

Is it time to be interested in government bonds again?