The Inverted Curve, the Floating-Rate Guarantee, and a Client Who Wants to 'Lock In'
Your client Dana, 58, owns a precision-parts manufacturer and a $1.4 million personal portfolio: $600,000 in a five-year Treasury ladder averaging 4.15%, $450,000 in a listed REIT fund, and $350,000 in a money market fund. Over eighteen months the Federal Reserve raised the target rate 500 basis points. The two-year note now yields 4.90% and the ten-year 4.20%. CPI runs at 3.5% and core PCE at 2.8%. Dana plans to retire at 62 and wants $95,000 a year from the portfolio, indexed. Separately, the business carries a $750,000 line of credit priced at SOFR plus 275 basis points, which she has personally guaranteed. She tells you she wants to 'lock in 4.2% for ten years' with the bond money.
1. Dana wants to extend the entire Treasury ladder to ten years at 4.20%. Using the curve, her balance sheet, and her four-year runway to retirement, evaluate that recommendation.
Read the worked answer
Curve math. 2s at 4.90 against 10s at 4.20 is roughly 70 bp of inversion. Extending from an average maturity of five years to ten picks up about 5 bp of yield (4.15 to 4.20) while roughly doubling duration. That is poor compensation for interest-rate risk - the market is paying almost nothing for duration.
Balance-sheet mismatch. The $750,000 line at SOFR + 275 is currently costing roughly 7.5% to 7.9% if SOFR sits near 4.8% to 5.2%. It resets continuously. With her personal guarantee, Dana's liabilities are extremely short-duration. Locking her assets at 4.20% for ten years behind a 7.7% floating liability is negative carry: any business stress forces her to sell ladder rungs into whatever prices prevail.
Runway. Retirement in four years with a $95,000 draw on $1.4 million is a 6.8% withdrawal rate - already aggressive. She cannot afford a duration mismatch on top of it.
What to recommend instead. Keep the ladder in the one-to-five-year range and barbell it, or hold T-bills sized to two years of business debt service (about $115,000 of annual interest). Separately price a fixed-rate term loan or a pay-fixed swap so the business liability stops resetting. Extending the ladder is a rate call, not a plan.
2. Dana asks whether a recession that forces 200 basis points of Fed cuts would help or hurt her. Walk the scenario through each sleeve and say what it implies for the extension decision.
Read the worked answer
Money market and T-bills ($350,000). Hurt. A 200 bp cutting cycle takes front-end yields from roughly 5% toward 3% within a year. Pure reinvestment risk.
Short ladder rungs. Same problem - the one- and two-year rungs roll into lower coupons.
Floating-rate loan. Helped, materially. SOFR falls with the target rate, so the $750,000 line's cost drops from about 7.7% toward 5.7%, roughly $15,000 a year of interest saved. The guarantee becomes far less dangerous, and the business is less likely to need portfolio distributions.
Long Treasuries. Helped. Ten-year yields typically fall in a recession-driven easing cycle; a rung bought at 4.20% would show a mark-to-market gain, and the ladder would then have to reinvest at lower rates.
REITs. Mixed to negative. Lower discount rates help valuation, but recession hits occupancy, rents, and tenant credit, and leveraged REITs face refinancing. REITs fell hard in 2008 and 2020 even as rates collapsed.
Implication. The inverted curve is the market telling her the recession scenario is live. Her liabilities improve and her cash loses, so holding some duration is the hedge - but she does not need to buy it all at 4.20%. Split it: extend a third now, hold the rest in bills and short rungs, and add on further steepening. Note that CPI at 3.5% and core PCE at 2.8% are still above target, which caps how fast the Fed can cut; the market may be overpricing 200 bp.
3. Dana proposes selling the $450,000 REIT fund and buying ten-year Treasuries so that 'everything is safe.' Evaluate.
Read the worked answer
Concentration. After the swap she would hold $1,050,000 of nominal Treasuries and cash - 75% of the portfolio - against $350,000 of growth assets. She is 58, drawing 6.8%, with a 30-year horizon. That allocation cannot support the income need without invading principal.
Real yield. A 4.20% nominal Treasury against 3.5% CPI is roughly 0.7% real. That is a thin real return to accept on a third of the portfolio.
The risk she is actually exposed to. Her business costs and her $95,000 lifestyle both inflate. Rents give REITs some pass-through to inflation; nominal Treasuries give none. The swap trades inflation risk for rate risk and labels it safety.
Single-scenario bet. The trade only wins if inflation falls and stays down. If inflation persists, she loses on the Treasury's real return and gives up the REIT's growth at the bottom of a drawdown.
Alternative. If REIT volatility is the real complaint, trim - say from $450,000 to $250,000 - and pair part of the proceeds with TIPS or a short TIPS ladder, keeping nominal duration modest. Document the conversation: she is asking to change her objective, and that belongs in an updated IPS and a new risk-tolerance questionnaire, not in one trade.