Updated March 6, 2025
The Yield Curve & Your Portfolio: A Macro Investing Guide Applying Ray Dalio’s Principles and a Dynamic Yield Curve
The Yield Curve & Your Portfolio: A Macro Investing Guide Applying Ray Dalio’s Principles and a Dynamic Yield Curve
The Yield Curve & Your Portfolio: A Macro Investing Guide Applying Ray Dalio’s Principles and a Dynamic Yield Curve
AJ Giannone, CFA
The Macroscope
The yield curve reveals clues about economic expectations that impact asset classes
Analyzing rising and falling interest rates and the magnitude of those moves helps investors monitor and anticipate risks
Going overweight or underweight stock market sectors based on yield curve shifts is a key aspect of a dynamic asset allocation strategy
They say the bond market is smarter than the stock market. There might be something to that considering how large the global fixed-income arena is: nearly $150 trillion compared to the equity market’s $120 trillion value. The yield curve, specifically, is among the bellwether indicators of not only financial markets but also the economy writ large. Analyzing its shape has become a constant exercise on Wall Street. For everyday investors, the yield curve tells much about the market’s health, and from a macro perspective, opportunities within sectors arise as Treasury rates shift.
Billionaire hedge fund manager Ray Dalio has decades of experience parsing macro data. Among the major barometers he inspects is the yield curve and how it connects to other data points and trends. Let’s explore why the yield curve matters and how its movements affect the 11 stock market sectors along with other macro implications.
What is the Yield Curve?
The yield curve might sound like a tricky financial term, but it’s simple. It's just the graphical representation of bond yields (interest rates) and their maturities. The most common yield curve analysis plots US Treasury securities, which are considered default-risk-free assets. The difference between the rate on the 2-year Treasury note and the 10-year note is the most widely quoted yield curve measure. The rate spread between the 3-month bill and 10-year note is another popular yield curve gauge.
The Different Shapes of the Yield Curve
Source: Reserve Bank of Australia
Assessing Recession Probabilities Using the 10-Year-3-Month Treasury Yield Spread
Source: St. Louis Federal Reserve
Economists, analysts, and strategists sometimes compare the Treasury yield curve to that of investment-grade corporate bonds or even high-yield credit. You can also superimpose other countries’ bond markets along with Treasurys. Big picture, yield curves reflect investors’ collective expectations of future economic growth and inflation.
The most important thing to understand about the yield curve is what its shape implies. There are three main profiles it can take on:
Normal: Longer-term bonds offer higher yields than shorter-term bills and notes, reflecting the risk premium for holding bonds over time. The Treasury market is most often in a “normal yield curve” environment. Stocks usually do well, particularly growth companies and small caps, while long-term bonds underperform in a normal-yield curve situation.
Inverted: In rarer instances, short-term rates move above long-term rates, which is a classic harbinger of a recession or at least an economic slowdown. Defensive and high-quality stocks are preferred, and long-term bonds can rise in value, but the macro tone can quickly shift, so be ready to allocate more aggressively as a recession turns long in the tooth.
Flat: Yields across the maturity spectrum are similar; this usually happens during transitions in the macro cycle. Coming out from an inversion, historical data show that small- and mid-cap stocks have outperformed.
Stocks Have Done Well When the Yield Curve Uninverts
Source: Goldman Sachs
So, a yield curve is never static; it moves around, sometimes violently so. As it flattens, steepens, or inverts, investors learn something new about the global macro picture, and connecting yield-curve clues to what’s happening with other macro indicators helps clarify where the economy is headed.
The Steepeners and Flatteners
All yield curve adjustments are not the same; we classify them as either steepeners or flatteners. Here’s what they mean:
Bull Steepener: Short-term rates fall faster than long-term rates, indicating heavy buying on the short end of the curve. This may indicate the early innings of a recession and/or a period when the Fed is cutting rates.
Bear Steepener: Long-term rates rise faster than short-term rates, perhaps due to inflationary pressures or simply from optimism that a period of high growth and economic expansion is in store. Bear steepeners can happen coming out of a recession.
Bull Flattener: Long-term rates fall faster than short-term rates; this can happen when growth hopes fade while the Fed and other central banks hold policy rates steady.
Bear Flattener: Short-term rates rise faster than long-term rates, which may happen as the Fed hikes the policy rate. The late 2021-mid-2023 period was an inflation-driven bear flattener as expectations increased that the Fed would aggressively tighten monetary policy to fight the jump in the CPI rate.
Dalio & The Economic Machine
Since the Treasury yield curve is always in flux, it’s helpful to view it as one of the facets of the economic machine. It connects seemingly detached pieces of the manufacturing and services sectors, as well as confidence in the government’s ability to make good on its financial obligations. Credit cycles, current and future interest rates, and financial system leverage all play roles in molding the yield curve’s shape. As interest rates shift along the term structure, clues about economic fundamentals reveal themselves.
The Bridgewater Associates founder also asserts that diversification is the holy grail of investing. Diversification doesn’t mean just owning a boatload of asset classes and funds, and then calling it a day, however. Yield curve dynamics can help investors go overweight or underweight sectors, geographies, and, yes, even asset classes.
We call this “dynamic asset allocation.” Allio’s Managed Macro Portfolios helps investors cut through market noise to home in on true drivers of market performance, thereby helping identify and allocate to better risk/reward opportunities.
Impact on Sectors: How the Yield Curve Shapes Market Behavior
Let’s dive into the nitty-gritty. At the sector level, changes in the yield curve influence the 11 stock market sectors differently. Sensitivity to interest rates, growth expectations, inflation, and the term premium all matter. Here are the 11 sectors, ranked by size in the All-Country World Index, and how the yield curve matters to each:
Information Technology
It used to be that higher long-term interest rates would be a detriment to high-growth tech stocks since most of their cash flows and earnings were expected to come in the future. As markets are wont to do, things have changed. Today’s biggest tech stocks are cash-heavy and debt-light, so yield curve dynamics are less impactful to the so-called Magnificent companies.
Still, for lower-quality tech (think: Cathie Wood stocks), when bonds go through a bear market, it can hit high-duration (highly interest-rate-sensitive) tech stocks the hardest. In aggregate, a normal, upward-sloping yield curve often benefits Information Technology.
Financials
Banks and other financial institutions commonly benefit from a steeper yield curve. So, coming out of a recession when a bear steepener might play out, owning shares in the Financials sector could work well. Banks borrow short and lend long, so as the yield curve steepens, their net interest margins usually rise.
There’s risk here, though, since many smaller banks hold significant portfolios of loans that can be marked down in value when rates jump. More broadly, value stocks are said to outperform growth shares as the yield curve steepens.
Consumer Discretionary
The third largest global stock market sector and perhaps the most tied to the health of the economy, Consumer Discretionary is sensitive to the shape of the yield curve and how it transforms. An inverted yield curve is a clear headwind for retail, travel, and luxury goods companies as higher borrowing costs and reduced disposable income crimps household spending. A normal yield curve is ideal for this cyclical slice of the stock market.
Industrials
Industrials do best in the early recovery phase of the economic cycle; it's the classic mid-bull market play. So, a normal (upward-sloping) yield curve is the most favorable condition for blue chips like machinery, transportation, and aerospace & defense stocks.
Health Care
Health Care is the biggest of the defensive sectors; it may outperform as fears of a recession rise. Going overweight pharmaceutical companies when there are signs of a market top and as economic indicators suggest some overheating can generate alpha. An inverted yield curve may also attract capital to the perceived safety of Health Care. The space boasts the best return among the 11 sectors during bull steepeners.
Communication Services
Communication Services, about 8% of the global stock market, acts like tech-light. It holds shares of companies that may not be as cyclical as many tech names, but its duration can still be high. The group tends to do relatively well as the yield curve steepens coming out of recession and shortly after the bottom of a bear market.
Consumer Staples
Consumer Staples, those tried-and-true household brands, are less affected by economic cycles and yield curve dynamics. Their steady cash flows and predictable dividend yields turn attractive during the throes of a bear market. Staples usually offer alpha when the yield curve flattens too.
Energy
Commodities and Energy are highly cyclical, so interest rates play a big role. Shares of oil & gas companies prefer a steepening yield curve as it signals rising inflation expectations. (Higher inflation means more costly oil in most circumstances.) Not all situations are the same, however, and some of the best price action in the Energy sector occurred when the Treasury yield curve was in a bear flattener from early 2021 to the middle of 2022.
2021-2022: Inflation Fears Reflected Higher Oil Prices, Bear Flattening Yield Curve
Source: TradingView
Materials
Materials is another “reflation” trade. The resource-rich group does well as GDP growth forecasts turn up and longer-term rates rise faster than short-term rates. Copper stocks, agricultural plays, and chemical companies often outperform as the economy accelerates into high gear, but they also tend to top close to the overall market’s peak.
Utilities
The third in the triad of true defensives, Utilities commonly offer steady returns as fear rises. A flattening yield curve, or even an inverted one, draws investors to the steadiness of power generation companies. Again, though, there’s nuance in that if short-term rates rise too much, then Treasury bills may turn into formidable competition compared to the high dividend yields of Utilities.
Real Estate
The smallest global stock market sector is Real Estate. The area houses Real Estate Investment Trusts (REITs) which rely on debt financing. So, rising rates and a steepening yield curve can be problematic as interest expense jumps. Real Estate tends to do best at the onset of a recession since yields decline then, but it's the worst area during both bull and bear steepeners.
The Crossroads of Dalio’s Determinants and Yield Curve Dynamics
A steady yield curve is a positive indicator for an economy. A normal yield curve signals both tame inflation expectations, a robust growth outlook, and confidence that the government can pay its bills. As it applies to Dalio’s determinants and measures of power, the yield curve most directly reflects Innovation & Technology, Trade, Economic Output, Markets and Financial Center, and Reserve Currency Status.
Innovation & Technology
A leading world power must possess tech prowess. Worker productivity grows, potential GDP increases, and inflation is held in check when a country is at the forefront of innovation. In such scenarios, interest rates may be elevated as the demand for financing capital is high while the yield curve itself is steep, suggesting a sanguine growth outlook.
Trade
A sovereign bond yield curve also highlights the strength and potential risks of trade policy. When there is high demand for the home country’s goods, and net exports rise, then that’s a positive sign for GDP growth, thereby steepening the yield curve. Conversely, if global trade slows (via tariffs, trade wars, or supply chain problems), then the growth outlook dims, causing a flatter or even inverted yield curve. Heightened geopolitical concerns can stymie global trade, flattening the yield curve in a “flight to safety” trade.
Economic Output
As potential economic growth increases, the yield curve should rise and steepen. Countries that promote free-market policies and encourage private-sector investment stand the best chance to maximize long-run economic output. Pro-growth initiatives should be reflected in a steeper yield curve while countries that nationalize industries, tax households and businesses, and exhibit growing wealth gaps may have flatter yield curves.
Today, there is talk of a rising “term premium” on the Treasury curve. Some pundits suggest it's a sign that the federal government could be unable to pay some of its bills years from now, but it is really a more hopeful view of the long-term growth outlook. You see, the Term premium began to rise in September of 2024, as then former President Trump rose in the election polls. Following his victory, the term premium increased once more. At the same time, the US dollar gained ground versus other currencies and the S&P 500 rose, too. If there were true fears of Treasury defaults, then we certainly would not have seen such currency and stock-market moves.
Rising US Treasury Term Premium
Source: Bloomberg
Markets and Financial Center
Financial markets that encourage risk-taking and have low counterparty risk reflect economic strength, and robust capital markets typically result in a normal, upward-sloping yield curve. In the US, confidence that the Federal Reserve can effectively steer monetary policy is crucial.
At the same time, fiscal spending should be done responsibly to maintain the Treasury’s long-term credibility. Today, with the national debt soaring in recent years and burgeoning annual budget deficits, there’s the risk that the US could lose its market and financial center leadership.
Large US Budget Deficits As Nominal GDP Grows
Source: BofA Global Research
Reserve Currency Status
To boast reserve currency status, sovereign yields need to be at a healthy level. That means not too high, but also not being manipulated downward. As it stands, US Treasurys are purchased by other central banks, multinational corporations, and individual investors due to their assumed zero risk of default. If that confidence is threatened, then both short-term and long-term rates could jump, and quickly so.
Reserve currency status for the US means our policymakers have the bandwidth to be more aggressive with monetary and fiscal policy. We saw that during the 2008 Great Financial Crisis and as the COVID-19 pandemic played out. This policy flexibility goes hand-in-hand with a lower country risk premium, but it doesn’t mean bond-market volatility will be low or that yield curve inversions will be avoided, as we’ve seen since 2020.
Navigating Volatile Yield Curve Swings: A Dynamic Asset Allocation
Is the US dollar the world’s reserve currency? Yes. Will it always be that way? History suggests no. The key thing for investors today is to understand that macro variables are always in flux. Thus, adopting a dynamic asset allocation strategy is critical. That means assessing the macro indicators, identifying your own return needs and risk tolerance, and then allocating appropriately.
At Allio, you can build a portfolio that diversifies across the seven asset classes (stocks, bonds, cash, real estate, commodities, gold, and cryptocurrency) while spreading out risk across the 11 stock market sectors. If indicators point to rising inflation expectations, then a tactical play could be to reduce exposure to nominal bonds while increasing exposure to inflation-protected fixed income, such as TIPS.
Keeping on top of the Fed’s policy actions—whether they may raise or lower interest rates—is a major factor in how the yield curve evolves. As it twists and turns, being dynamic with your stock portfolio allows you to perform sector rotation. For your bond sleeve, being in the know about the yield curve can help you manage interest-rate risk (duration). Finally, currency developments matter, too, and if growth deteriorates at home, then going abroad can help mitigate the risk of a falling dollar. These are just some real-world portfolio moves you can consider when viewing yield curve dynamics in the broader macro picture.
The Bottom Line
The yield curve is among the most telling macro indicators. As interest rates move up and down and the shape and slope of the curve adjusts, astute macro investors have a leg up. You don’t have to be a seasoned investor to grasp the concepts—just possessing a basic understanding of what the yield curve is and what information it's relaying to investors is a big advantage.
At Allio, our macro-investing philosophy focuses on the powerful factors that shape markets: economics, policy, and politics. Those forces reveal themselves in interest rates and yield curves. Our Macro Dashboard helps investors navigate complex markets and stay ahead of economic shifts.
The yield curve reveals clues about economic expectations that impact asset classes
Analyzing rising and falling interest rates and the magnitude of those moves helps investors monitor and anticipate risks
Going overweight or underweight stock market sectors based on yield curve shifts is a key aspect of a dynamic asset allocation strategy
They say the bond market is smarter than the stock market. There might be something to that considering how large the global fixed-income arena is: nearly $150 trillion compared to the equity market’s $120 trillion value. The yield curve, specifically, is among the bellwether indicators of not only financial markets but also the economy writ large. Analyzing its shape has become a constant exercise on Wall Street. For everyday investors, the yield curve tells much about the market’s health, and from a macro perspective, opportunities within sectors arise as Treasury rates shift.
Billionaire hedge fund manager Ray Dalio has decades of experience parsing macro data. Among the major barometers he inspects is the yield curve and how it connects to other data points and trends. Let’s explore why the yield curve matters and how its movements affect the 11 stock market sectors along with other macro implications.
What is the Yield Curve?
The yield curve might sound like a tricky financial term, but it’s simple. It's just the graphical representation of bond yields (interest rates) and their maturities. The most common yield curve analysis plots US Treasury securities, which are considered default-risk-free assets. The difference between the rate on the 2-year Treasury note and the 10-year note is the most widely quoted yield curve measure. The rate spread between the 3-month bill and 10-year note is another popular yield curve gauge.
The Different Shapes of the Yield Curve
Source: Reserve Bank of Australia
Assessing Recession Probabilities Using the 10-Year-3-Month Treasury Yield Spread
Source: St. Louis Federal Reserve
Economists, analysts, and strategists sometimes compare the Treasury yield curve to that of investment-grade corporate bonds or even high-yield credit. You can also superimpose other countries’ bond markets along with Treasurys. Big picture, yield curves reflect investors’ collective expectations of future economic growth and inflation.
The most important thing to understand about the yield curve is what its shape implies. There are three main profiles it can take on:
Normal: Longer-term bonds offer higher yields than shorter-term bills and notes, reflecting the risk premium for holding bonds over time. The Treasury market is most often in a “normal yield curve” environment. Stocks usually do well, particularly growth companies and small caps, while long-term bonds underperform in a normal-yield curve situation.
Inverted: In rarer instances, short-term rates move above long-term rates, which is a classic harbinger of a recession or at least an economic slowdown. Defensive and high-quality stocks are preferred, and long-term bonds can rise in value, but the macro tone can quickly shift, so be ready to allocate more aggressively as a recession turns long in the tooth.
Flat: Yields across the maturity spectrum are similar; this usually happens during transitions in the macro cycle. Coming out from an inversion, historical data show that small- and mid-cap stocks have outperformed.
Stocks Have Done Well When the Yield Curve Uninverts
Source: Goldman Sachs
So, a yield curve is never static; it moves around, sometimes violently so. As it flattens, steepens, or inverts, investors learn something new about the global macro picture, and connecting yield-curve clues to what’s happening with other macro indicators helps clarify where the economy is headed.
The Steepeners and Flatteners
All yield curve adjustments are not the same; we classify them as either steepeners or flatteners. Here’s what they mean:
Bull Steepener: Short-term rates fall faster than long-term rates, indicating heavy buying on the short end of the curve. This may indicate the early innings of a recession and/or a period when the Fed is cutting rates.
Bear Steepener: Long-term rates rise faster than short-term rates, perhaps due to inflationary pressures or simply from optimism that a period of high growth and economic expansion is in store. Bear steepeners can happen coming out of a recession.
Bull Flattener: Long-term rates fall faster than short-term rates; this can happen when growth hopes fade while the Fed and other central banks hold policy rates steady.
Bear Flattener: Short-term rates rise faster than long-term rates, which may happen as the Fed hikes the policy rate. The late 2021-mid-2023 period was an inflation-driven bear flattener as expectations increased that the Fed would aggressively tighten monetary policy to fight the jump in the CPI rate.
Dalio & The Economic Machine
Since the Treasury yield curve is always in flux, it’s helpful to view it as one of the facets of the economic machine. It connects seemingly detached pieces of the manufacturing and services sectors, as well as confidence in the government’s ability to make good on its financial obligations. Credit cycles, current and future interest rates, and financial system leverage all play roles in molding the yield curve’s shape. As interest rates shift along the term structure, clues about economic fundamentals reveal themselves.
The Bridgewater Associates founder also asserts that diversification is the holy grail of investing. Diversification doesn’t mean just owning a boatload of asset classes and funds, and then calling it a day, however. Yield curve dynamics can help investors go overweight or underweight sectors, geographies, and, yes, even asset classes.
We call this “dynamic asset allocation.” Allio’s Managed Macro Portfolios helps investors cut through market noise to home in on true drivers of market performance, thereby helping identify and allocate to better risk/reward opportunities.
Impact on Sectors: How the Yield Curve Shapes Market Behavior
Let’s dive into the nitty-gritty. At the sector level, changes in the yield curve influence the 11 stock market sectors differently. Sensitivity to interest rates, growth expectations, inflation, and the term premium all matter. Here are the 11 sectors, ranked by size in the All-Country World Index, and how the yield curve matters to each:
Information Technology
It used to be that higher long-term interest rates would be a detriment to high-growth tech stocks since most of their cash flows and earnings were expected to come in the future. As markets are wont to do, things have changed. Today’s biggest tech stocks are cash-heavy and debt-light, so yield curve dynamics are less impactful to the so-called Magnificent companies.
Still, for lower-quality tech (think: Cathie Wood stocks), when bonds go through a bear market, it can hit high-duration (highly interest-rate-sensitive) tech stocks the hardest. In aggregate, a normal, upward-sloping yield curve often benefits Information Technology.
Financials
Banks and other financial institutions commonly benefit from a steeper yield curve. So, coming out of a recession when a bear steepener might play out, owning shares in the Financials sector could work well. Banks borrow short and lend long, so as the yield curve steepens, their net interest margins usually rise.
There’s risk here, though, since many smaller banks hold significant portfolios of loans that can be marked down in value when rates jump. More broadly, value stocks are said to outperform growth shares as the yield curve steepens.
Consumer Discretionary
The third largest global stock market sector and perhaps the most tied to the health of the economy, Consumer Discretionary is sensitive to the shape of the yield curve and how it transforms. An inverted yield curve is a clear headwind for retail, travel, and luxury goods companies as higher borrowing costs and reduced disposable income crimps household spending. A normal yield curve is ideal for this cyclical slice of the stock market.
Industrials
Industrials do best in the early recovery phase of the economic cycle; it's the classic mid-bull market play. So, a normal (upward-sloping) yield curve is the most favorable condition for blue chips like machinery, transportation, and aerospace & defense stocks.
Health Care
Health Care is the biggest of the defensive sectors; it may outperform as fears of a recession rise. Going overweight pharmaceutical companies when there are signs of a market top and as economic indicators suggest some overheating can generate alpha. An inverted yield curve may also attract capital to the perceived safety of Health Care. The space boasts the best return among the 11 sectors during bull steepeners.
Communication Services
Communication Services, about 8% of the global stock market, acts like tech-light. It holds shares of companies that may not be as cyclical as many tech names, but its duration can still be high. The group tends to do relatively well as the yield curve steepens coming out of recession and shortly after the bottom of a bear market.
Consumer Staples
Consumer Staples, those tried-and-true household brands, are less affected by economic cycles and yield curve dynamics. Their steady cash flows and predictable dividend yields turn attractive during the throes of a bear market. Staples usually offer alpha when the yield curve flattens too.
Energy
Commodities and Energy are highly cyclical, so interest rates play a big role. Shares of oil & gas companies prefer a steepening yield curve as it signals rising inflation expectations. (Higher inflation means more costly oil in most circumstances.) Not all situations are the same, however, and some of the best price action in the Energy sector occurred when the Treasury yield curve was in a bear flattener from early 2021 to the middle of 2022.
2021-2022: Inflation Fears Reflected Higher Oil Prices, Bear Flattening Yield Curve
Source: TradingView
Materials
Materials is another “reflation” trade. The resource-rich group does well as GDP growth forecasts turn up and longer-term rates rise faster than short-term rates. Copper stocks, agricultural plays, and chemical companies often outperform as the economy accelerates into high gear, but they also tend to top close to the overall market’s peak.
Utilities
The third in the triad of true defensives, Utilities commonly offer steady returns as fear rises. A flattening yield curve, or even an inverted one, draws investors to the steadiness of power generation companies. Again, though, there’s nuance in that if short-term rates rise too much, then Treasury bills may turn into formidable competition compared to the high dividend yields of Utilities.
Real Estate
The smallest global stock market sector is Real Estate. The area houses Real Estate Investment Trusts (REITs) which rely on debt financing. So, rising rates and a steepening yield curve can be problematic as interest expense jumps. Real Estate tends to do best at the onset of a recession since yields decline then, but it's the worst area during both bull and bear steepeners.
The Crossroads of Dalio’s Determinants and Yield Curve Dynamics
A steady yield curve is a positive indicator for an economy. A normal yield curve signals both tame inflation expectations, a robust growth outlook, and confidence that the government can pay its bills. As it applies to Dalio’s determinants and measures of power, the yield curve most directly reflects Innovation & Technology, Trade, Economic Output, Markets and Financial Center, and Reserve Currency Status.
Innovation & Technology
A leading world power must possess tech prowess. Worker productivity grows, potential GDP increases, and inflation is held in check when a country is at the forefront of innovation. In such scenarios, interest rates may be elevated as the demand for financing capital is high while the yield curve itself is steep, suggesting a sanguine growth outlook.
Trade
A sovereign bond yield curve also highlights the strength and potential risks of trade policy. When there is high demand for the home country’s goods, and net exports rise, then that’s a positive sign for GDP growth, thereby steepening the yield curve. Conversely, if global trade slows (via tariffs, trade wars, or supply chain problems), then the growth outlook dims, causing a flatter or even inverted yield curve. Heightened geopolitical concerns can stymie global trade, flattening the yield curve in a “flight to safety” trade.
Economic Output
As potential economic growth increases, the yield curve should rise and steepen. Countries that promote free-market policies and encourage private-sector investment stand the best chance to maximize long-run economic output. Pro-growth initiatives should be reflected in a steeper yield curve while countries that nationalize industries, tax households and businesses, and exhibit growing wealth gaps may have flatter yield curves.
Today, there is talk of a rising “term premium” on the Treasury curve. Some pundits suggest it's a sign that the federal government could be unable to pay some of its bills years from now, but it is really a more hopeful view of the long-term growth outlook. You see, the Term premium began to rise in September of 2024, as then former President Trump rose in the election polls. Following his victory, the term premium increased once more. At the same time, the US dollar gained ground versus other currencies and the S&P 500 rose, too. If there were true fears of Treasury defaults, then we certainly would not have seen such currency and stock-market moves.
Rising US Treasury Term Premium
Source: Bloomberg
Markets and Financial Center
Financial markets that encourage risk-taking and have low counterparty risk reflect economic strength, and robust capital markets typically result in a normal, upward-sloping yield curve. In the US, confidence that the Federal Reserve can effectively steer monetary policy is crucial.
At the same time, fiscal spending should be done responsibly to maintain the Treasury’s long-term credibility. Today, with the national debt soaring in recent years and burgeoning annual budget deficits, there’s the risk that the US could lose its market and financial center leadership.
Large US Budget Deficits As Nominal GDP Grows
Source: BofA Global Research
Reserve Currency Status
To boast reserve currency status, sovereign yields need to be at a healthy level. That means not too high, but also not being manipulated downward. As it stands, US Treasurys are purchased by other central banks, multinational corporations, and individual investors due to their assumed zero risk of default. If that confidence is threatened, then both short-term and long-term rates could jump, and quickly so.
Reserve currency status for the US means our policymakers have the bandwidth to be more aggressive with monetary and fiscal policy. We saw that during the 2008 Great Financial Crisis and as the COVID-19 pandemic played out. This policy flexibility goes hand-in-hand with a lower country risk premium, but it doesn’t mean bond-market volatility will be low or that yield curve inversions will be avoided, as we’ve seen since 2020.
Navigating Volatile Yield Curve Swings: A Dynamic Asset Allocation
Is the US dollar the world’s reserve currency? Yes. Will it always be that way? History suggests no. The key thing for investors today is to understand that macro variables are always in flux. Thus, adopting a dynamic asset allocation strategy is critical. That means assessing the macro indicators, identifying your own return needs and risk tolerance, and then allocating appropriately.
At Allio, you can build a portfolio that diversifies across the seven asset classes (stocks, bonds, cash, real estate, commodities, gold, and cryptocurrency) while spreading out risk across the 11 stock market sectors. If indicators point to rising inflation expectations, then a tactical play could be to reduce exposure to nominal bonds while increasing exposure to inflation-protected fixed income, such as TIPS.
Keeping on top of the Fed’s policy actions—whether they may raise or lower interest rates—is a major factor in how the yield curve evolves. As it twists and turns, being dynamic with your stock portfolio allows you to perform sector rotation. For your bond sleeve, being in the know about the yield curve can help you manage interest-rate risk (duration). Finally, currency developments matter, too, and if growth deteriorates at home, then going abroad can help mitigate the risk of a falling dollar. These are just some real-world portfolio moves you can consider when viewing yield curve dynamics in the broader macro picture.
The Bottom Line
The yield curve is among the most telling macro indicators. As interest rates move up and down and the shape and slope of the curve adjusts, astute macro investors have a leg up. You don’t have to be a seasoned investor to grasp the concepts—just possessing a basic understanding of what the yield curve is and what information it's relaying to investors is a big advantage.
At Allio, our macro-investing philosophy focuses on the powerful factors that shape markets: economics, policy, and politics. Those forces reveal themselves in interest rates and yield curves. Our Macro Dashboard helps investors navigate complex markets and stay ahead of economic shifts.
The yield curve reveals clues about economic expectations that impact asset classes
Analyzing rising and falling interest rates and the magnitude of those moves helps investors monitor and anticipate risks
Going overweight or underweight stock market sectors based on yield curve shifts is a key aspect of a dynamic asset allocation strategy
They say the bond market is smarter than the stock market. There might be something to that considering how large the global fixed-income arena is: nearly $150 trillion compared to the equity market’s $120 trillion value. The yield curve, specifically, is among the bellwether indicators of not only financial markets but also the economy writ large. Analyzing its shape has become a constant exercise on Wall Street. For everyday investors, the yield curve tells much about the market’s health, and from a macro perspective, opportunities within sectors arise as Treasury rates shift.
Billionaire hedge fund manager Ray Dalio has decades of experience parsing macro data. Among the major barometers he inspects is the yield curve and how it connects to other data points and trends. Let’s explore why the yield curve matters and how its movements affect the 11 stock market sectors along with other macro implications.
What is the Yield Curve?
The yield curve might sound like a tricky financial term, but it’s simple. It's just the graphical representation of bond yields (interest rates) and their maturities. The most common yield curve analysis plots US Treasury securities, which are considered default-risk-free assets. The difference between the rate on the 2-year Treasury note and the 10-year note is the most widely quoted yield curve measure. The rate spread between the 3-month bill and 10-year note is another popular yield curve gauge.
The Different Shapes of the Yield Curve
Source: Reserve Bank of Australia
Assessing Recession Probabilities Using the 10-Year-3-Month Treasury Yield Spread
Source: St. Louis Federal Reserve
Economists, analysts, and strategists sometimes compare the Treasury yield curve to that of investment-grade corporate bonds or even high-yield credit. You can also superimpose other countries’ bond markets along with Treasurys. Big picture, yield curves reflect investors’ collective expectations of future economic growth and inflation.
The most important thing to understand about the yield curve is what its shape implies. There are three main profiles it can take on:
Normal: Longer-term bonds offer higher yields than shorter-term bills and notes, reflecting the risk premium for holding bonds over time. The Treasury market is most often in a “normal yield curve” environment. Stocks usually do well, particularly growth companies and small caps, while long-term bonds underperform in a normal-yield curve situation.
Inverted: In rarer instances, short-term rates move above long-term rates, which is a classic harbinger of a recession or at least an economic slowdown. Defensive and high-quality stocks are preferred, and long-term bonds can rise in value, but the macro tone can quickly shift, so be ready to allocate more aggressively as a recession turns long in the tooth.
Flat: Yields across the maturity spectrum are similar; this usually happens during transitions in the macro cycle. Coming out from an inversion, historical data show that small- and mid-cap stocks have outperformed.
Stocks Have Done Well When the Yield Curve Uninverts
Source: Goldman Sachs
So, a yield curve is never static; it moves around, sometimes violently so. As it flattens, steepens, or inverts, investors learn something new about the global macro picture, and connecting yield-curve clues to what’s happening with other macro indicators helps clarify where the economy is headed.
The Steepeners and Flatteners
All yield curve adjustments are not the same; we classify them as either steepeners or flatteners. Here’s what they mean:
Bull Steepener: Short-term rates fall faster than long-term rates, indicating heavy buying on the short end of the curve. This may indicate the early innings of a recession and/or a period when the Fed is cutting rates.
Bear Steepener: Long-term rates rise faster than short-term rates, perhaps due to inflationary pressures or simply from optimism that a period of high growth and economic expansion is in store. Bear steepeners can happen coming out of a recession.
Bull Flattener: Long-term rates fall faster than short-term rates; this can happen when growth hopes fade while the Fed and other central banks hold policy rates steady.
Bear Flattener: Short-term rates rise faster than long-term rates, which may happen as the Fed hikes the policy rate. The late 2021-mid-2023 period was an inflation-driven bear flattener as expectations increased that the Fed would aggressively tighten monetary policy to fight the jump in the CPI rate.
Dalio & The Economic Machine
Since the Treasury yield curve is always in flux, it’s helpful to view it as one of the facets of the economic machine. It connects seemingly detached pieces of the manufacturing and services sectors, as well as confidence in the government’s ability to make good on its financial obligations. Credit cycles, current and future interest rates, and financial system leverage all play roles in molding the yield curve’s shape. As interest rates shift along the term structure, clues about economic fundamentals reveal themselves.
The Bridgewater Associates founder also asserts that diversification is the holy grail of investing. Diversification doesn’t mean just owning a boatload of asset classes and funds, and then calling it a day, however. Yield curve dynamics can help investors go overweight or underweight sectors, geographies, and, yes, even asset classes.
We call this “dynamic asset allocation.” Allio’s Managed Macro Portfolios helps investors cut through market noise to home in on true drivers of market performance, thereby helping identify and allocate to better risk/reward opportunities.
Impact on Sectors: How the Yield Curve Shapes Market Behavior
Let’s dive into the nitty-gritty. At the sector level, changes in the yield curve influence the 11 stock market sectors differently. Sensitivity to interest rates, growth expectations, inflation, and the term premium all matter. Here are the 11 sectors, ranked by size in the All-Country World Index, and how the yield curve matters to each:
Information Technology
It used to be that higher long-term interest rates would be a detriment to high-growth tech stocks since most of their cash flows and earnings were expected to come in the future. As markets are wont to do, things have changed. Today’s biggest tech stocks are cash-heavy and debt-light, so yield curve dynamics are less impactful to the so-called Magnificent companies.
Still, for lower-quality tech (think: Cathie Wood stocks), when bonds go through a bear market, it can hit high-duration (highly interest-rate-sensitive) tech stocks the hardest. In aggregate, a normal, upward-sloping yield curve often benefits Information Technology.
Financials
Banks and other financial institutions commonly benefit from a steeper yield curve. So, coming out of a recession when a bear steepener might play out, owning shares in the Financials sector could work well. Banks borrow short and lend long, so as the yield curve steepens, their net interest margins usually rise.
There’s risk here, though, since many smaller banks hold significant portfolios of loans that can be marked down in value when rates jump. More broadly, value stocks are said to outperform growth shares as the yield curve steepens.
Consumer Discretionary
The third largest global stock market sector and perhaps the most tied to the health of the economy, Consumer Discretionary is sensitive to the shape of the yield curve and how it transforms. An inverted yield curve is a clear headwind for retail, travel, and luxury goods companies as higher borrowing costs and reduced disposable income crimps household spending. A normal yield curve is ideal for this cyclical slice of the stock market.
Industrials
Industrials do best in the early recovery phase of the economic cycle; it's the classic mid-bull market play. So, a normal (upward-sloping) yield curve is the most favorable condition for blue chips like machinery, transportation, and aerospace & defense stocks.
Health Care
Health Care is the biggest of the defensive sectors; it may outperform as fears of a recession rise. Going overweight pharmaceutical companies when there are signs of a market top and as economic indicators suggest some overheating can generate alpha. An inverted yield curve may also attract capital to the perceived safety of Health Care. The space boasts the best return among the 11 sectors during bull steepeners.
Communication Services
Communication Services, about 8% of the global stock market, acts like tech-light. It holds shares of companies that may not be as cyclical as many tech names, but its duration can still be high. The group tends to do relatively well as the yield curve steepens coming out of recession and shortly after the bottom of a bear market.
Consumer Staples
Consumer Staples, those tried-and-true household brands, are less affected by economic cycles and yield curve dynamics. Their steady cash flows and predictable dividend yields turn attractive during the throes of a bear market. Staples usually offer alpha when the yield curve flattens too.
Energy
Commodities and Energy are highly cyclical, so interest rates play a big role. Shares of oil & gas companies prefer a steepening yield curve as it signals rising inflation expectations. (Higher inflation means more costly oil in most circumstances.) Not all situations are the same, however, and some of the best price action in the Energy sector occurred when the Treasury yield curve was in a bear flattener from early 2021 to the middle of 2022.
2021-2022: Inflation Fears Reflected Higher Oil Prices, Bear Flattening Yield Curve
Source: TradingView
Materials
Materials is another “reflation” trade. The resource-rich group does well as GDP growth forecasts turn up and longer-term rates rise faster than short-term rates. Copper stocks, agricultural plays, and chemical companies often outperform as the economy accelerates into high gear, but they also tend to top close to the overall market’s peak.
Utilities
The third in the triad of true defensives, Utilities commonly offer steady returns as fear rises. A flattening yield curve, or even an inverted one, draws investors to the steadiness of power generation companies. Again, though, there’s nuance in that if short-term rates rise too much, then Treasury bills may turn into formidable competition compared to the high dividend yields of Utilities.
Real Estate
The smallest global stock market sector is Real Estate. The area houses Real Estate Investment Trusts (REITs) which rely on debt financing. So, rising rates and a steepening yield curve can be problematic as interest expense jumps. Real Estate tends to do best at the onset of a recession since yields decline then, but it's the worst area during both bull and bear steepeners.
The Crossroads of Dalio’s Determinants and Yield Curve Dynamics
A steady yield curve is a positive indicator for an economy. A normal yield curve signals both tame inflation expectations, a robust growth outlook, and confidence that the government can pay its bills. As it applies to Dalio’s determinants and measures of power, the yield curve most directly reflects Innovation & Technology, Trade, Economic Output, Markets and Financial Center, and Reserve Currency Status.
Innovation & Technology
A leading world power must possess tech prowess. Worker productivity grows, potential GDP increases, and inflation is held in check when a country is at the forefront of innovation. In such scenarios, interest rates may be elevated as the demand for financing capital is high while the yield curve itself is steep, suggesting a sanguine growth outlook.
Trade
A sovereign bond yield curve also highlights the strength and potential risks of trade policy. When there is high demand for the home country’s goods, and net exports rise, then that’s a positive sign for GDP growth, thereby steepening the yield curve. Conversely, if global trade slows (via tariffs, trade wars, or supply chain problems), then the growth outlook dims, causing a flatter or even inverted yield curve. Heightened geopolitical concerns can stymie global trade, flattening the yield curve in a “flight to safety” trade.
Economic Output
As potential economic growth increases, the yield curve should rise and steepen. Countries that promote free-market policies and encourage private-sector investment stand the best chance to maximize long-run economic output. Pro-growth initiatives should be reflected in a steeper yield curve while countries that nationalize industries, tax households and businesses, and exhibit growing wealth gaps may have flatter yield curves.
Today, there is talk of a rising “term premium” on the Treasury curve. Some pundits suggest it's a sign that the federal government could be unable to pay some of its bills years from now, but it is really a more hopeful view of the long-term growth outlook. You see, the Term premium began to rise in September of 2024, as then former President Trump rose in the election polls. Following his victory, the term premium increased once more. At the same time, the US dollar gained ground versus other currencies and the S&P 500 rose, too. If there were true fears of Treasury defaults, then we certainly would not have seen such currency and stock-market moves.
Rising US Treasury Term Premium
Source: Bloomberg
Markets and Financial Center
Financial markets that encourage risk-taking and have low counterparty risk reflect economic strength, and robust capital markets typically result in a normal, upward-sloping yield curve. In the US, confidence that the Federal Reserve can effectively steer monetary policy is crucial.
At the same time, fiscal spending should be done responsibly to maintain the Treasury’s long-term credibility. Today, with the national debt soaring in recent years and burgeoning annual budget deficits, there’s the risk that the US could lose its market and financial center leadership.
Large US Budget Deficits As Nominal GDP Grows
Source: BofA Global Research
Reserve Currency Status
To boast reserve currency status, sovereign yields need to be at a healthy level. That means not too high, but also not being manipulated downward. As it stands, US Treasurys are purchased by other central banks, multinational corporations, and individual investors due to their assumed zero risk of default. If that confidence is threatened, then both short-term and long-term rates could jump, and quickly so.
Reserve currency status for the US means our policymakers have the bandwidth to be more aggressive with monetary and fiscal policy. We saw that during the 2008 Great Financial Crisis and as the COVID-19 pandemic played out. This policy flexibility goes hand-in-hand with a lower country risk premium, but it doesn’t mean bond-market volatility will be low or that yield curve inversions will be avoided, as we’ve seen since 2020.
Navigating Volatile Yield Curve Swings: A Dynamic Asset Allocation
Is the US dollar the world’s reserve currency? Yes. Will it always be that way? History suggests no. The key thing for investors today is to understand that macro variables are always in flux. Thus, adopting a dynamic asset allocation strategy is critical. That means assessing the macro indicators, identifying your own return needs and risk tolerance, and then allocating appropriately.
At Allio, you can build a portfolio that diversifies across the seven asset classes (stocks, bonds, cash, real estate, commodities, gold, and cryptocurrency) while spreading out risk across the 11 stock market sectors. If indicators point to rising inflation expectations, then a tactical play could be to reduce exposure to nominal bonds while increasing exposure to inflation-protected fixed income, such as TIPS.
Keeping on top of the Fed’s policy actions—whether they may raise or lower interest rates—is a major factor in how the yield curve evolves. As it twists and turns, being dynamic with your stock portfolio allows you to perform sector rotation. For your bond sleeve, being in the know about the yield curve can help you manage interest-rate risk (duration). Finally, currency developments matter, too, and if growth deteriorates at home, then going abroad can help mitigate the risk of a falling dollar. These are just some real-world portfolio moves you can consider when viewing yield curve dynamics in the broader macro picture.
The Bottom Line
The yield curve is among the most telling macro indicators. As interest rates move up and down and the shape and slope of the curve adjusts, astute macro investors have a leg up. You don’t have to be a seasoned investor to grasp the concepts—just possessing a basic understanding of what the yield curve is and what information it's relaying to investors is a big advantage.
At Allio, our macro-investing philosophy focuses on the powerful factors that shape markets: economics, policy, and politics. Those forces reveal themselves in interest rates and yield curves. Our Macro Dashboard helps investors navigate complex markets and stay ahead of economic shifts.
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Disclosures
This material is for informational purposes only and should not be construed as financial, legal, or tax advice. You should consult your own financial, legal, and tax advisors before engaging in any transaction. Information, including hypothetical projections of finances, may not take into account taxes, commissions, or other factors which may significantly affect potential outcomes. This material should not be considered an offer or recommendation to buy or sell a security. While information and sources are believed to be accurate, Allio Capital does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Performance could be volatile; an investment in a fund or an account may lose money.
There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
Disclosures
This material is for informational purposes only and should not be construed as financial, legal, or tax advice. You should consult your own financial, legal, and tax advisors before engaging in any transaction. Information, including hypothetical projections of finances, may not take into account taxes, commissions, or other factors which may significantly affect potential outcomes. This material should not be considered an offer or recommendation to buy or sell a security. While information and sources are believed to be accurate, Allio Capital does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Performance could be volatile; an investment in a fund or an account may lose money.
There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
Disclosures
This material is for informational purposes only and should not be construed as financial, legal, or tax advice. You should consult your own financial, legal, and tax advisors before engaging in any transaction. Information, including hypothetical projections of finances, may not take into account taxes, commissions, or other factors which may significantly affect potential outcomes. This material should not be considered an offer or recommendation to buy or sell a security. While information and sources are believed to be accurate, Allio Capital does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Performance could be volatile; an investment in a fund or an account may lose money.
There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
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Allio Advisors LLC ("Allio") is an SEC registered investment advisor. By using this website, you accept our Terms of Service and our Privacy Policy. Allio's investment advisory services are available only to residents of the United States. Nothing on this website should be considered an offer, recommendation, solicitation of an offer, or advice to buy or sell any security. The information provided herein is for informational and general educational purposes only and is not investment or financial advice. Additionally, Allio does not provide tax advice and investors are encouraged to consult with their tax advisor. By law, we must provide investment advice that is in the best interest of our client. Please refer to Allio's ADV Part 2A Brochure for important additional information. Please see our Customer Relationship Summary.
Online trading has inherent risk due to system response, execution price, speed, liquidity, market data and access times that may vary due to market conditions, system performance, market volatility, size and type of order and other factors. An investor should understand these and additional risks before trading. Any historical returns, expected returns, or probability projections are hypothetical in nature and may not reflect actual future performance. Past performance is no guarantee of future results.
Brokerage services will be provided to Allio clients through Allio Markets LLC, ("Allio Markets") SEC-registered broker-dealer and member FINRA/SIPC . Securities in your account protected up to $500,000. For details, please see www.sipc.org. Allio Advisors LLC and Allio Markets LLC are separate but affiliated companies.
Securities products are: Not FDIC insured · Not bank guaranteed · May lose value
Any investment , trade-related or brokerage questions shall be communicated to support@alliocapital.com
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What We Do
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Allio Advisors LLC ("Allio") is an SEC registered investment advisor. By using this website, you accept our Terms of Service and our Privacy Policy. Allio's investment advisory services are available only to residents of the United States. Nothing on this website should be considered an offer, recommendation, solicitation of an offer, or advice to buy or sell any security. The information provided herein is for informational and general educational purposes only and is not investment or financial advice. Additionally, Allio does not provide tax advice and investors are encouraged to consult with their tax advisor. By law, we must provide investment advice that is in the best interest of our client. Please refer to Allio's ADV Part 2A Brochure for important additional information. Please see our Customer Relationship Summary.
Online trading has inherent risk due to system response, execution price, speed, liquidity, market data and access times that may vary due to market conditions, system performance, market volatility, size and type of order and other factors. An investor should understand these and additional risks before trading. Any historical returns, expected returns, or probability projections are hypothetical in nature and may not reflect actual future performance. Past performance is no guarantee of future results.
Brokerage services will be provided to Allio clients through Allio Markets LLC, ("Allio Markets") SEC-registered broker-dealer and member FINRA/SIPC . Securities in your account protected up to $500,000. For details, please see www.sipc.org. Allio Advisors LLC and Allio Markets LLC are separate but affiliated companies.
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