Market Perspectives - December 2017

1. Market Perspective – December 2017
Experience Insight Impact
Overview: As 2017 comes to an end, with markets focused on Tax Reform (our topic next
month), many investors are growing concerned with the flattening of the yield curve. History
tells us that at times, the flattening of interest rates across maturities can be a harbinger of
recessionary conditions. This month, we analyze both the current fixed income environment and
what to monitor going forward in relation to the shape of the yield curve.
1

2. Yield Curve Defined
Experience Insight Impact
• The treasury yield curve
is a line that plots
interest rates at various
points in maturity
assuming equal credit
quality. Most investors
use treasury bonds as a
proxy for this.
• Traditionally, investors
will require a higher
yield to lend their capital
for longer periods of
time, thereby creating
an upward sloping
graphical view as shown
at the right. Source: Bloomberg
2
Rate(in%)
Time to Maturity

3. Why Does This Matter?
Experience Insight Impact
The vast majority of the time, the curve is upward sloping. Investors seek to be paid extra yield for the
uncertainty of holding longer-dated securities (e.g. the risk of heightened inflation). However, there are
several scenarios which cause consternation for investors:
• Weakening Economy - Investors want the certainty of return if the economy weakens. This drives
demand to longer-dated bonds, which reduces their rates. At the same time, demand for shorter-
dated bonds declines, pushing their yields higher. This is what investors call a “flattening” of the
yield curve. If economic conditions appear dire enough, then the curve may invert, meaning short
maturity bonds offer a higher rate than longer maturity bonds.
 Throughout history, markets have always viewed the inversion of the “yield curve” as a
harbinger of recessions.
• Strengthening Economy - As economic activity picks up steam, the Federal Reserve, with their
mandate to keep prices stable, will raise rates to cool off an economy that looks inflationary. This
may push short rates higher.
• Currently, the concern is that over the last 12 months, short-term rates have risen and longer-term
rates have fallen, which has led to a flattening yield curve as indicated on the following slide.
3

4. Yield Curve Concerns
Reminder: The yield curve represents the yield earned by an investor for accepting different maturities. Typically, it takes a higher yield for an investor
to accept a longer dated security. As the risk of recession grows, an inversion in the yield curve tends to signify the choking off of growth capital.
Experience Insight Impact 4
• Since 12/31/16, the yield
curve has undeniably
flattened for a variety of
reasons. (The green solid line
is as of 12/11/17, and the
yellow dotted line is as of
12/31/16.)
• This year, short-term interest
rates have risen, due at least
in part to the Federal
Reserve’s actions.
• At the same time, longer-
term rates have remained
stubbornly low as inflation
expectations remain largely
contained. There are several
other reasons creating
demand for bonds at the
long end.
Source: Bloomberg

5. Shorter-Term Global Yields Remain Negative For Many Countries
U.S. yields may be artificially low due to continued quantitative easing from around the world. The table above lists 2-year yields from
countries around the globe, many of which are currently negative (see yellow). U.S. yields look more attractive relative to the global fixed
income environment, thereby potentially skewing true fixed income demand and pricing.
Experience Insight Impact 5
Source: Bloomberg

6. Yield Curve Concerns
At the present time, the curve is not inverted. However, spreads between short-term and longer-term yields are the
narrowest in a decade. The yield curve has inverted before all of the recessions in the last 50 years, although the exact
timing remains inconsistent. For example, the first inversion from the 2008 financial crisis actually occurred in
December 2005, several years ahead of the recession.
Experience Insight Impact 6

7. Market Perspective – December 2017
Experience Insight Impact
Conclusion: The past year has seen the yield curve flatten meaningfully, placing investors in a
watchful waiting mode for the next moves. With an inversion being a relatively reliable indicator
of recession, we understand the concern. At the present time, however, the curve remains
comfortably upward sloping, and it must be recognized that this is simply one variable for
investors to watch. Our eyes remain focused on a wide variety of evidence to support our
investment stance, with the shape of the yield curve being one of those factors.
7

8. Disclaimer
Experience Insight Impact
Opinions expressed in this commentary may change as conditions warrant and is for informational
purposes only. Information contained herein is not intended to be personal investment advice for
any specific person for any particular purpose. We utilize information sources that we believe to
be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee
of future performance; investing involves risk and may result in loss of capital. Consider seeking
advice from a professional before implementing any investing strategy.
8