When it comes to investing in fixed-income securities, it’s all about yield. And more importantly, it’s about the so-called yield curve. This measure of yields along a set line of different maturities within the same credit quality can tell a lot about investor thinking and how future returns, risks, and other points will play out.
And right now, the yield curve is a bit volatile to say the least.
We’ve gone from being inverted to flattening to going back to being invested once again as President Trump’s tariffs have been announced. For fixed-income investors, the current yield-curve environment is interesting and requires a deft approach to play.
Stubborn Inflation, Tariffs, & Recession Risk
Under normal conditions, investors are compensated for holding longer maturing debt. The odds of a corporation or the U.S. government defaulting on its securities in three months are slim, but over 10 or 30 years, who knows? As a result, a short-term T-bill will pay a lower yield, while a 30-year bond will pay a much higher coupon. This is what typically happens.
We measure this change by plotting the yields of various maturities of the same quality of bonds. Investors will usually plot the two- and 10-year yields, while some economists favor the distance between three-month bills and 10-year notes. But the idea is the same, and the curve slopes upward. Short-term debt yields less than longer-term debt.
But every once in a while, a strange thing happens. The relationship changes, and short-term bonds yield more than longer-term ones. There are a variety of circumstances why this happens, but much of it stems from uncertainty. If you hop into a time machine and go back a few years, this is exactly what happened. Inflation was running high, and the Fed needed to raise rates — which instantly affects short-term bonds — and the yields on the short end of the curve rose. And, in fact, according to financial group LPL, 2022–2024 was the longest and deepest yield-curve inversion in modern history. 1
It took until December 2024 for the yield curve to steepen. After troughing at -1.09% — meaning the 2-year yield was higher than the 10-year yield by over 1% — the Fed’s rate cuts started to work their way through the system, and the yield curve moved back into its normal position of longer-term bonds yielding more than shorter-term ones. For example, the U.S. 3-month Treasury bill yield declined from 5.33% at the end of 2023 to 4.28% at the end of 2024, while the 10-year was closer to 4.65%.
Then, in one week, it all went to hell.
With President Trump’s hefty tariff announcements, bond traders have gotten spooked. Predicted to have cataclysmic consequences for global trade and the U.S. economy, and increase the chance of a recession to almost guarantee, traders have rushed into long-term debt to lock in high yields and ride out the storm. Last Wednesday, the yield on the 10-year note passed below that of the 3-month note. This chart from CNBC highlights the shift in yield-curve leadership.
Source: CNBC.com
A Tough Environment
The problem is, the tariffs and the economic effects have turned the page on the bond market playbook and thrown uncertainty into the mix. What was working a few weeks ago may not work today. Essentially, the inverted curve is forecasting pain for the economy and the stock market.
The question is, how can fixed-income investors navigate the inverted curve? The answer is to think about the middle.
If the tariffs have the predicted effect of recession, the Federal Reserve will be forced to cut rates to jump-start the economy. This will naturally reduce the yields on the shortened end of the curve and could eventually steepen once again. T-bills and short-term bonds will yield less, whereas long-term bonds will yield more.
The issue is whether traders will continue to buy long-term bonds to lock in those yields amid the recession and score higher yields than cash — which will bring down the yields on long-term bonds. This is happening right now.
The answer could be in the middle of the curve. Bonds with maturities of 3 to 7 years are the pivot point for the curve. While short-term and long-term yields undulate, those in the middle tend to stay flat. This provides a lower volatility choice for fixed-income investors while still managing to pick up decent yields.
The proof is in the data. Looking at data from the last seven Fed rate pauses/cuts, intermediate bonds have historically outperformed cash and other short-term bonds by a wide margin, outperforming by 3 percentage points after a year and 2 percentage points after three years on average. Conversely, over the last decade, there have been three periods of rising rates, and intermediate bonds have still managed to produce flat to slight gains when it comes to total returns.
It turns out that the middle could offer the best scenario for income seekers or for investors looking towards bonds to provide a lower volatility choice to equities.
How To Get the Middle Ground
Given the uncertainty amid tariffs, the inverted yield curve, rising recession risk, and overall volatility of the bond market, finding a place in the middle could be the answer. Ultimately, intermediate bonds and those with maturities of 3 to 7 years could be a wonderful bet for investors.
Getting that exposure can be done in one of two ways.
The easy way is to focus on intermediate funds. Thanks to their mandates, these bond funds will hold debt within this framework. Another way could be to barbell to match a similar overall duration profile. This means buying short-term and long-term debt, which will average an intermediate maturity profile. However, this could be a bumpier option as these two points on the curve will move up or down, whereas the intermediate bond fund would be the pivot point.
Either way, the wonkiness of the yield curve means that investors need to change their thinking and focus on the middle.
For now, investors have plenty of choices when it comes to adding alternative credit and other bonds outside investment-grade bonds to their portfolios. For most of us, this is all we need.
Intermediate Treasury Bond ETFs
These funds are selected based on exposure to intermediate Treasury bonds and the 10-year Treasury note. They are sorted by their YTD total return, which ranges from 2.5% to 3.5%. Their expense ratio ranges from 0.03% to 0.15%, with AUM between $162M and $40B. They are currently yielding between 3.1% and 4.3%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| UTEN | US Treasury 10 Year Note ETF | $162M | 3.5% | 4.3% | 0.15% | ETF | No |
| IEF | iShares 7-10 Year Treasury Bond ETF | $33.1B | 3.4% | 3.5% | 0.15% | ETF | No |
| SPTI | SPDR Portfolio Intermediate Term Treasury ETF | $7.5B | 2.8% | 3.5% | 0.03% | ETF | No |
| VGIT | Vanguard Intermediate-Term Treasury ETF | $39.6B | 2.7% | 3.5% | 0.03% | ETF | No |
| SCHR | Schwab Intermediate-Term U.S. Treasury ETF | $10.4B | 2.7% | 3.6% | 0.03% | ETF | No |
| IEI | iShares 3-7 Year Treasury Bond ETF | $15.8B | 2.5% | 3.1% | 0.15% | ETF | No |
In the end, the tariffs have once again thrown uncertainty into the yield curve and the economy. This has inverted the curve and created a difficult-to-navigate environment for fixed-income investors. The secret could be finding solace in the middle. Intermediate bonds offer the best place to ride out the storm as the short and long ends of the curve pivot.
Bottom Line
The yield curve is again inverting as Trump’s tariff plans take hold and uncertainty grows. Long-term bonds now yield less than those on the short end. With so much volatility, it makes sense to find a place in the middle to ride out the storm.
1 LPL (January 2025). Yield Curves Have Steepened, but They’re Still Not Steep
