Individual Bonds Benefit From Yield Curve Shift

Doug Drabik discusses fixed income market conditions and offers insight for bond investors.

The United States central bank – the Federal Reserve – reversed its monetary policy on September 18, 2024, by beginning to cut the Fed Funds rate. The Federal Open Market Committee (FOMC) meets eight times per year to contemplate open market operations, including its decision on the Fed Funds rate. It is sometimes perceived that the Fed’s action changes all interest rates across the yield curve, but that needs to be put in perspective. The Fed cut interest rates in each of the last three FOMC meetings in 2024. The total accumulation of cuts amounted to moving the Fed Funds rate down by 100 basis points.

It was highly anticipated that the Fed would begin to cut interest rates. The bond market often begins to react to the news or in anticipation of where investors believe interest rates are going, sometimes well in advance of the action itself. The graph below highlights the “before” and “after” effects of the Fed’s actions. What is evident is that it has only brought short-term interest rates down. Intermediate and longer-term interest rates have risen since the Fed began cutting the Fed Funds rate in September.

Upper bound fed funds rate

The takeaways are numerous. Short money market instruments remain viable for liquidity purposes but lose luster in long-term portfolio planning. The income potential is greatly diminished. The good news is that intermediate and longer-term investment choices have picked up significantly in terms of income potential. With the yield curve turning into an upward-sloping shape, investors are once again rewarded with higher income when taking on interest rate risk associated with longer-term investments.

Treasury Yield Curve Change