A bear steepener is a term used to describe a situation in the bond market where long-term interest rates rise faster than short-term interest rates, resulting in a wider gap or spread between them. This causes the yield curve, which plots the yields of bonds with different maturities, to become steeper.
A bear steepener is usually a sign of rising inflation expectations, which means that investors anticipate higher prices and lower purchasing power in the future. This makes long-term bonds less attractive, as their fixed payments will be worth less over time. Therefore, investors demand higher yields to hold long-term bonds, which pushes their prices down and their yields up.
A bear steepener can also be triggered by an increase in the supply of long-term bonds, which can happen when the government issues more debt to finance its spending or stimulus programs. This can create an excess of long-term bonds in the market, which lowers their prices and raises their yields.
A bear steepener can have negative implications for the stock market, as it can signal a deterioration of economic conditions and a tightening of monetary policy. Higher long-term interest rates can increase the borrowing costs for businesses and consumers, which can reduce their spending and investment. Higher long-term interest rates can also lower the present value of future earnings for companies, which can reduce their stock prices.
How a bear steepener is affecting the stock market now
The bond market is currently experiencing a bear steepener, as the yield on the 10-year Treasury has risen to 4.15%, 0.28 percentage point more than the two-year Treasury yield. This is the widest spread between the two yields since 2022.
The main drivers of the bear steepener are the rising inflation expectations and the increased debt issuance by the Treasury Department. The consumer price index (CPI), which measures the changes in the prices of goods and services, rose 5.4% year-over-year in July 2023, the highest rate since 2008. The Treasury Department also announced that it would have to issue $2.3 trillion of debt in the second half of 2023, up from $1.9 trillion estimated in May.
The bear steepener has already started to affect the stock market, as investors are becoming more cautious and risk-averse. The S&P 500 index, which tracks the performance of 500 large U.S. companies, has fallen 3.2% from its record high on July 26. The sectors that are most sensitive to interest rates, such as utilities, real estate, and consumer staples, have underperformed the broader market. The sectors that are more dependent on economic growth, such as technology, consumer discretionary, and industrials, have also faced pressure from the bear steepener.
How to protect your portfolio from a bear steepener
Investors who are concerned about a bear steepener in the bond market can take some steps to protect their portfolio from its potential impact on the stock market. Here are some possible strategies:
- Reduce exposure to long-term bonds and increase exposure to short-term bonds or cash equivalents. This can help reduce the duration risk or sensitivity to interest rate changes of your portfolio. Short-term bonds or cash equivalents can also provide liquidity and flexibility in case of market volatility.
- Diversify your portfolio across different asset classes and sectors. This can help reduce the correlation or co-movement of your portfolio with the bond market or any specific sector. Diversifying your portfolio can also help capture opportunities in different markets or sectors that may benefit from a bear steepener.
- Focus on quality stocks with strong fundamentals and competitive advantages. These stocks can offer resilience and growth potential in any market environment. Quality stocks can also pay dividends or buy back shares, which can enhance their total return and attractiveness for investors.
