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Is the Treasury Yield Curve Sending Out a Troublesome Message?
Money and Markets
Mike Larson
12/4/2015
Excerpt: | Friday, December 4, 2015 at 7:30 am
... I’m a bit worried about the troublesome message the curve is sending out. To understand why, let me start with the yield curve basics.
First, the government issues Treasury bills, notes and bonds with a wide range of maturities — from as little as one month all the way out to 10 and 30 years.
If you plot the yields on each of those Treasuries on a piece of graph paper, then draw a line connecting them, you get a picture of the current Treasury yield curve.
Second, the yield curve is a living, breathing indicator. After all, as investors buy and sell Treasuries, the yields on those Treasuries constantly fluctuate. That causes the shape of the yield curve to change as well.
Third and most importantly, the shape of the curve can tell you important things about monetary policy, the economy, inflation fears and market expectations about the future.
When investors are confident about the future growth outlook, and fearful of inflation, they buy shorter-term Treasuries and sell longer-term ones. This causes short-term yields to remain relatively low, even as longer-term yields rise.
That, in turn, gives you a “steep” yield curve — one that slopes up and to the right. That’s because the plot points for 10-year and 30-year Treasuries are much higher than the plot points for 1-year or 2-year Treasuries.
When Federal Reserve policymakers start talking about raising short-term interest rates, or actually raise them, the process begins to change. Investors start selling short-term Treasuries to avoid losses stemming from the central bank hikes. Then they do one of two things:
1) If they fear the central bank is “behind the curve” and not raising rates aggressively enough to stamp out future inflation, they sell long-term Treasuries, too. That means the yield curve stays steep because all rates rise at essentially the same pace.
2) If they worry that the central bank hikes are too aggressive and that the economy can’t handle the pressure, they start buying long-term Treasuries. The bet they’re making? The Fed hikes will crush future growth and inflation, or even drive the economy into recession. This causes the yield curve to flatten, because long-term yields fall even as short-term yields rise.
That brings me to present day. Investors aren’t aggressively selling longer-term Treasuries. They’re holding on to them, even as they’re selling at the front end of the curve. That’s causing the curve and key rate spreads to compress.
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View the complete article, including image, at:
http://www.moneyandmarkets.com/treas...0#.VmHLZr-SkxI
Money and Markets
Mike Larson
12/4/2015
Excerpt: | Friday, December 4, 2015 at 7:30 am
... I’m a bit worried about the troublesome message the curve is sending out. To understand why, let me start with the yield curve basics.
First, the government issues Treasury bills, notes and bonds with a wide range of maturities — from as little as one month all the way out to 10 and 30 years.
If you plot the yields on each of those Treasuries on a piece of graph paper, then draw a line connecting them, you get a picture of the current Treasury yield curve.
Second, the yield curve is a living, breathing indicator. After all, as investors buy and sell Treasuries, the yields on those Treasuries constantly fluctuate. That causes the shape of the yield curve to change as well.
Third and most importantly, the shape of the curve can tell you important things about monetary policy, the economy, inflation fears and market expectations about the future.
When investors are confident about the future growth outlook, and fearful of inflation, they buy shorter-term Treasuries and sell longer-term ones. This causes short-term yields to remain relatively low, even as longer-term yields rise.
That, in turn, gives you a “steep” yield curve — one that slopes up and to the right. That’s because the plot points for 10-year and 30-year Treasuries are much higher than the plot points for 1-year or 2-year Treasuries.
When Federal Reserve policymakers start talking about raising short-term interest rates, or actually raise them, the process begins to change. Investors start selling short-term Treasuries to avoid losses stemming from the central bank hikes. Then they do one of two things:
1) If they fear the central bank is “behind the curve” and not raising rates aggressively enough to stamp out future inflation, they sell long-term Treasuries, too. That means the yield curve stays steep because all rates rise at essentially the same pace.
2) If they worry that the central bank hikes are too aggressive and that the economy can’t handle the pressure, they start buying long-term Treasuries. The bet they’re making? The Fed hikes will crush future growth and inflation, or even drive the economy into recession. This causes the yield curve to flatten, because long-term yields fall even as short-term yields rise.
That brings me to present day. Investors aren’t aggressively selling longer-term Treasuries. They’re holding on to them, even as they’re selling at the front end of the curve. That’s causing the curve and key rate spreads to compress.
..................................................
View the complete article, including image, at:
http://www.moneyandmarkets.com/treas...0#.VmHLZr-SkxI