Bond investors can reduce duration — or interest rate risk — by selecting bonds or bond ETFs with short-term maturities, and they can increase their interest rate risk by selecting bonds or bond ETFs with longer maturities.
Currently, longer-term interest rates are lower than short-term term interest rates, a situation known as an inverted yield curve.5 The yield curve is a visualization of interest rates available at a specific point in time on bonds with the same credit quality — such as U.S. Treasuries — but with different maturity dates.
Typically, longer-term yields are higher than those of bonds with shorter maturities. This compensates investors for the risk of holding bonds for a longer period, as more time equals more uncertainty about the future path of inflation and interest rates. (For example, no one in could have predicted the inflation spike in 2020-22 amid the COVID-19 pandemic and Russia’s invasion of Ukraine; both disrupted global trade and led to shortages of some items.)
The current yield curve inversion is a reflection that the market expects short-term rates to decline in the future, so longer-term rates are lower. What’s unusual about the current inversion is that it has already lasted 22 months. Previous inversions in 2000 and 2006 lasted 10 months and six months, respectively.6 This ongoing, long-lasting inversion is occurring as the market thinks the Fed will be successful at bringing inflation down and is expected to cut rates. The Fed’s Summary of Economic Projections also projects the federal funds rate to converge to 2.8% over a long-term time frame.7
We anticipate that the yield curve will revert to short-term rates being higher than longer-term rates, known as a normalization of term structure, eventually resulting in an upward sloping yield curve. While short rates should eventually decline with Fed cuts, we think rates on the long end of the yield curve will instead be driven by investors expecting more yield for longer maturities. (Read more about our views on current opportunities in bonds.)