The Yield Curve Is Flattening — Here’s What It Means for Annuities
Immediate annuity rates are up a bit from last month, but potentially not by as much as you’d expect given the news that the 10 Year Treasury is finally hovering around 3%.
In this article, I’ll discuss the recent increase in 10 Year Treasury yields, why short-term rates have jumped more than long-term rates, and what it all means for future annuity payouts.
Why 10 Year Bond Yields Matter
For as long as we’ve analyzed annuity payouts, we’ve been talking about the 10 Year Treasury as a good barometer for how annuity payouts will change.
So it comes as no surprise that we’ve fielded a lot of calls, emails and texts over the last week about what’s happening with annuity payouts now that Treasury yields eclipsed 3% for the first time in a very long time.
Why Some Bond Yields Are Increasing More than Others
Actually, the recent commotion in the bond markets has not been driven by the 10 Year Treasury’s return to 3%. Rather, the thing most bond market experts are talking about is the flattening of the yield curve.
So, what’s the yield curve? And what does it mean to say that it is flattening? And how does this affect your retirement?
The Yield Curve
If you plot Treasury yields for various maturities with the shortest maturities on the left (1 month, 3 month, etc.) and the longest on the right (10 year, 30 year, etc.), you’d have a yield curve.
The typical yield curve is upward sloping. That’s the case today. When the yield curve has this shape, it means that investors demand more yield (return) for Treasury bonds of longer maturities.
A Flattening Yield Curve
Below is the US Treasury yield curve. The red line is today. The yellow line is from a year ago. You’ll notice that although both slope upward, the red line is much flatter than the yellow. That is, the difference between very short-term bonds and very long-term bonds was larger a year ago than it is today. Yields on the 30 Year Treasury have barely budged from where they were a year ago, while yields of shorter term Treasuries have increased around 1%.
Why is this happening? Since the beginning of 2017 the Federal Reserve, our country’s central bank, has raised short-term interest rates 4 times, from 0.5%-0.75% to 1.5%-1.75%. According to Bloomberg, bond traders are pricing in more than two additional Fed rate hikes by the end of this year, and have baked in almost four by the end of 2019, Fed funds futures data show. These rate hikes tend to have a smaller impact on longer-term Treasuries, which are driven more by investor/consumer outlook for the future.
Where Are Annuity Rates Increasing the Most?
Some annuity rates have increased significantly. For example, the short-term, fixed rate annuities with guarantee periods of 3-5 years have increased significantly over the last year. That’s not surprising given that’s where the yield curve has shifted up the most. On the other hand, income annuities, which are longer in duration than fixed rate annuities, have seen a smaller increase.
In this environment where the difference between the 5 year and the 30 year bond is so small, there are a couple strategies worth considering.
- Buy a fixed rate annuity (also known as a multi year guaranteed annuity or MYGA) with a 3, 4 or 5 year maturity with the plan of buying income later.
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- Start buying small amounts of a deferred income annuity, such that future contributions would benefit from rising rates.
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Both of these strategies will work best if the yield curve were to steepen and rates rise from here. If the yield were to steepen, meaning the spread between the 2 Year and 10 Year Treasuries INCREASES, then you would see the most impact on long-duration immediate and deferred income annuities and less of an impact on shorter duration fixed rate annuities. We don’t have a crystal ball, and predicting future changes in interest rates and bond yields is not our purview. If payout rates move the other direction, you might regret not locking in more income sooner.
Read More about the Yield Curve
I’ve found that the best writing about interest rate movements can be found in the Wall Street Journal (WSJ). The WSJ, however, is behind a paywall, so if you don’t have a subscription, here are a few other good sources.
- Bloomberg: The Yield Curve Is Flattening Again After Strong Eco Data
- Bloomberg: Flat Yield Curve Is Just What the U.S. Economy Needs
- Investopedia: Four Scenarios: Fed Policy, the Yield Curve and Recessions
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