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Will a Steepening Yield Curve Boost Financials and the Broader Economy?

Conditions for a steepening yield curve are forming.

The Federal Reserve cut its benchmark fed funds rate by 25 basis points at its September meeting, and there are indications that more rate cuts are on the horizon. If the next few meetings go as many market participants anticipate, yields on the short end of the curve are poised to keep falling.

Meanwhile, yields on the longer end of the curve (10-year and 30-year U.S. Treasurys) have been steadily climbing. As seen on the chart below, 30-year U.S. Treasury bond yields recently brushed 5%, and the 10-year has remained above 4% all year.  

Yields on 10-Year U.S Treasurys (blue line) and 30-Year U.S. Treasurys (green line)

As I wrote in a recent column, there are a few reasons to believe we could see sustained pressure on long duration bond yields. Debt issuance has picked up after the summer lull, increasing supply. Sentiment could also play a role—after years of near-zero interest rates and heavy central bank buying, investors have grown more sensitive to small shifts in expectations about growth, inflation, and policy. Expectations of lower growth and higher inflation can push yields up.

In that same column, I framed this dynamic as a potential positive. I argued that with central banks cutting short-term rates and long yields drifting higher, yield curves could be set to steepen, which is a classic marker of healthier credit conditions since it improves incentives for banks to lend. Remember, the basic business model of banking relies on borrowing money at short-term rates and putting it to work through longer-term loans. When the yield curve slopes upward, long rates exceeding short, banks have higher incentive to extend credit widely because the margin is in their favor.

The chart below shows the yield curve as the difference between yields on 3-month U.S. Treasurys and 10-year U.S. Treasurys. It’s clear that the yield curve has been flat for some time, but as outlined above, there’s a reasonably good thesis that we could see more steepening ahead.

3-Month / 10-Year U.S. Treasury Bond Yield Curve (below zero is inverted, above zero is steep)

A steeper yield curve is generally good news, but I want to be careful not to portray it as a definitive game-changer.

Although the correlation is relatively tight, banks’ lending margins don’t map directly to government bond spreads. Banks’ funding costs are shaped more by the abundance of deposits, swollen in recent years by pandemic-era fiscal transfers, than by short-term Treasury yields. Loan pricing, meanwhile, generally runs above long-term government yields, reflecting higher credit risk. This helps explain why loan growth (see chart below) has remained steady even during the curve’s inversion. In other words, banks did not suddenly stop lending when the curve flipped upside down, so it’s unlikely that merely un-inverting will spark a dramatic new lending boom.

To be sure, a modestly positive slope can provide a tailwind for Financials stocks, and it may offer some incremental support to credit creation. But as a barometer for the U.S. economy overall, the curve’s current steepening is more symbolic than fundamental. The bigger picture is that lending activity never really faltered, and the economy has kept grinding ahead despite widespread worries.

Bottom Line for Investors

A steepening yield curve is positive, and it can add some support for Financials. But I do not think we’re in a place in this cycle where a steeper curve will fundamentally alter the economic outlook. The U.S. economy remains sturdier than many appreciate, with strong employment and steady loan growth underscoring that resilience. For investors, a steeper yield curve is something to celebrate, but it’s not a panacea for weakness that could emerge elsewhere in the economy.

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