Food For Thought: Ideal Interest Rate vs. the Yield Curve

Includes: IEF, SPY, TBT, TLT
by: Vikram Saxena

On April 27, FT carried an article which showed that an internal study at the Fed suggested that the ideal interest for the current economic situation was -5%.

Today the 2yr-30yr bond yield spread stands at 325 bp.

According to Across The Curve the highest level reached by this spread was 367bp, when the 2 year bond yielded 3.60 and the 30 year yielded 7.29 in October 1992.

This is an extreme divergence. On one hand, the Fed feels that it needs to go to negative interest rates to prevent deflation. On the other hand the yield curve is at one of its steepest levels, ever. This is a divergence of historic proportions and shows a market which is not balanced.

I am not sure for how long such an unstable state can continue. However, such imbalances typically do not end well for many market participants.