Yield curve inversions are abnormal and do not persist for a substantial period of time. There are only two ways in which the yield curve can normalize, either short- term rates can come down or long- term rates can rise. In the first scenario, short- term rates come down as a result of the central bank cutting rates to counteract any economic slowdown. In the second, either inflation outlook expectations are permanently anchored higher, and thus the market comes to believe that the central bank must keep rates higher for a very long period of time, or the country experiences a currency crisis and higher rates are required to prevent capital flight.
Which of these scenarios plays out will determine the relative value of Money Market funds and Stable Value funds. If the first scenario occurs and the US enters recession and cuts rates, then Money Market fund yields will drop, and Stable Value funds will quickly revert to their historical outperformance. If the second scenario occurs, Money Markets may prolong their yield advantage over Stable Value funds until intermediate- term rates rise above short- term rates and existing Stable Value assets mature and are reinvested. Historically, only the first scenario has occurred in the US due to the US Dollar’s reserve currency status.
We are now at the point where even Fed Chairman Jerome Powell is admitting that a soft landing is looking less and less likely.(9) Both of the scenarios above regarding how the yield curve may normalize will likely involve significant volatility and large potential losses to risk assets. In this environment, Stable Value will continue to serve its role as a principal protection product, sheltering a portion of 401(k) assets at a guaranteed crediting rate for participants.