Yield Curve Back Near Highs

With long-term interest rates rising and short-term rates remaining contained, the rising yield curve is once again starting to receive attention.  For those who are unfamiliar with the yield curve, we strongly suggest reading the NY Fed's discussion on the indicator as a leading indicator of economic activity.  In short, high values in the yield curve are positive for the economy, while an inverted yield curve (negative spread between long and short term rates) is a harbinger of economic weakness down the line.  While there are many variant definitions of the yield curve, for our analysis we defer to the NY Fed which defines the yield curve as the difference (in basis points) between the yield on the 10-Year and 3-Month US Treasury Note.  In the chart below, we highlight the historical spread between 10-year and 3-month Treasury yields.  As shown in the chart, the curve is currently at the high end of its historical range.  With the exception of 1982, the yield curve is now at similar levels where prior peaks occurred.  In the current period, the curve has made multiple attempts to break through the 380 bps level, but each time it has failed.  Will this be the run that takes the curve through the 400 basis point level, or will heavy resistance once again be too much for the spread to handle?

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Comments

[Paul Teetor]

Thanks for keeping us informed on yield curve developments. This is very helpful for getting that "big picture".

The steep yield curve suggests a couple of spread trades. One is long TLT and short IEF, which are both ETFs for Treasury bonds. Another is long 10-year Treasury futures and short 5-year Treasury futures. Either trade will profit from the flattening of the yield curve. I've got both spread trades in my portfolio, and I'm pleased with their progress.

Thanks again.

[professor pinch]

Nice chart. The New York Fed model has been telling us there's virtually no chance of a double-dip, largely because of this one metric.

So naturally, the contrarian in me wants to think about hedging, especially since liquidity is going to be getting drained. And soon. The only question is in which way does it flatten: the long end compressing or the short end rising? Or perhaps a bit of both?

Either way, the chart is telling: 380bps has been formidable resistance and it can't stay this wide ad infinitum.

[dj]

Good chart...i have been looking at the 2yr vs 10yr.....your chart has clear clean view ....thanks

[Panagiotis]

Thanks for the information. I understood that if the yield is inverse, then after a while there is recession and the stocks collapse. But does it really matter if the yield is 300, 380 or above 400 points? What are the implications for the stocks?

[Marrilyn]

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