• Flattening yield curve reflects lower inflation expectations
  • The Fed will likely increase rates again this year and two or three times next year
  • Corporate credit quality remains stable to slightly better

One measure we pay particular attention to when managing fixed income portfolios is the slope of the yield curve (measured by the difference between two-year and 10-year Treasury yields). This measure reflects the bond market’s consensus estimate of the future path of interest rates, which is based on both the Fed’s monetary policy as well as inflation expectations.


During the second quarter, we saw the slope of the yield curve decline materially, from 113 basis points (bps) to 91 bps at month’s end. Although some of this flattening was due to the Fed’s mid-June rate increase, most of it was due to a decline in 10-year yields. This is important because it implies a change in market expectations, in this case declining inflation expectations.

Lower inflation expectations have reduced market expectations regarding additional rate increases by the Fed. The market is signaling that it anticipates only one or two more hikes by the end of 2018. This contrasts with Fed projections of four additional rate hikes, supported by low unemployment with inflation of about 2%.

City National Rochdale expects the Fed will likely raise rates again later this year and perhaps two or three times next year, with long-term rates rising only modestly.

We also track corporate credit spreads, the incremental amount of yield that corporates offer over Treasuries. When credit quality deteriorates, corporate yields increase relative to Treasury rates. Corporate spreads declined modestly during the quarter, indicating stable to slightly improving credit quality. Leverage is higher, but this has been offset by lower interest costs, and we expect positive earnings growth going forward.


Even though corporate spreads are lower than in prior years, they reflect stable credit conditions and result in yields that are more attractive than Treasuries. Given a stable macroeconomic environment with rising earnings, we remain comfortable with our allocations to corporate bonds. That said, we will look for opportunities to increase overall credit quality by swapping lower-rated issuers for higher-rated ones when the yield difference is minimal.

Keep Reading: The Economic Trifecta

Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

Investments in Master Limited Partnerships (MLP) are susceptible to concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy, and market risk. Investors in MLPs are subject to increased tax reporting requirements. MLP investors typically receive a complicated schedule K-1 form rather than Form 1099. MLPs may not be appropriate investments for tax-advantaged accounts because of potential negative tax consequences (Unrelated Business Income Tax).

There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

Yield to Worst is the lower of the yield to maturity or the yield to call. It is essentially the lowest potential rate of return for a bond, excluding delinquency or default.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk. Past performance is no guarantee of future performance.

Index Definitions

The Standard & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.