U.S. 2-Year, 10-Year Yield Gap Hits Record Wide at 277 Basis Points

As reported by FT Alphaville citing Reuters as the source.

US 2-YR, 10-YR YIELD GAP HITS RECORD WIDE AT 277 BPS IN THE WAKE OF STRONGER-THAN-EXPECTED HOME DATA

Amidst the general confusion about direction in various asset classes there is one thing that I am confident about which is that, unless we get another major leg down to the rolling financial crisis (which is becoming more unpleasant to contemplate each day that the disconnect from mounting debt problems persists), the bull market in US Treasuries which carried from the October 1987 crash until December of 2008 is over.

Yields on the five year note seen in the chart above saw the largest relative jump yesterday and I would expect that as long as traders in equities and commodities continue to push the reflation agenda the market’s focus will move increasingly towards the shorter term securities, in particular 2 year notes.

Perversely the rates on short term bills are declining significantly at present - which I don’t believe is a positive for those claiming boldly that risk aversion is behind us.

Comments

[RiskReturnO...:]

Excellent new for the banks that avoided risky mortgages and credit cards. With oil prices high, Texas economic outlook appears to be much better than rest of US.

Best trade for this environment is Texas based banks, such as TCBI and MCBI. For those concerned about overall banking exposure, consider a hedge with XLF puts. The highest yield spread will be very profitable for the Texas banks that do not have to deal with legacy assets, and can focus on bringing in new deposits at 0.5% yield and lending at much higher rates.

Jun 02 03:15 PM

[conceptwizard:]

The Fed is really scared on the long term treasury yield getting out of control, in fact I think it may be.

Jun 02 08:34 PM

[dybydx:]

this is just utterly out of whack. QE policy makes holding gold, an investment strategy that involves doing.... ABSOLUTELY NOTHING.... look like the smartest thing since sliced bread. if the price of stocks somehow cant outpace gold... i'd cry myself to sleep.

Jun 03 01:01 AM

[Clive Corcoran:]

Concept wizard
You are correct and long term yields are not really within the control of the Fed even at the best of times (i.e. without trillion dollar deficits)
The one area that the Fed has some influence over is the shorter end and for markets in general it would be "unsettling" if - in order to stop the yield gap exploding even further upwards - there was even the whiff of an adjustment in the policy of complete accommodation to those now jump starting the equity markets

Jun 03 04:43 AM

[Steven Hansen:]

we are painting ourselves in the corner as the treasury is concentrating on short term debt financing when the debt we are incurring obviously has long term financing needs. we are kicking the can down the road.

this will not end well.

Jun 03 11:54 AM

[John Lounsbury:]

Clive, ConceptWizard and Steve - - -

Putting your comments together really covers a lot. A steep yield curve historically presages economic growth and, especially if the short end is also rising, future inflation. What it means this time is not that clear. It might indicate a fuse is lit that will blow up with a weak economic recovery getting crushed by high mortgage rates (and other longer-term credit), aggravated by high unemployment that just keeps growing (never actually peaking and starting a significant decline before the crushing effects of high longer-term interest rates).

Yes, RiskReturnOptimizer, the steep yield curve is nirvana for banks to reap high profits. But, if economic activity continues to contract, who will borrow?

Steve, you may well be right when you say - "this will not end well."
Paranoia? I think, rather, it is just prudent awareness of the possibilities.

Jun 03 03:07 PM

[Mistrofan:]

the use of 2/10 years spread is NOT appropiate and irreleveant in too many ways. 2 years has to ve compared with the 30y and the 10y with 6 months. Doing it this way you will see there are no records (yet) and we had these spreads in 2003 and 2004.

Jun 03 08:37 PM

[ain't no fo...:]

"Perversely the rates on short term bills are declining significantly at present - which I don’t believe is a positive for those claiming boldly that risk aversion is behind us."

Clive, the VIX has also been heading up off its lows and actually rallied hard when the Dow was up 220 Monday... not a coincidence I believe, and according to Bill Luby it was only the second time in many years that there had been such a strong disconnect.

"...the steep yield curve is nirvana for banks to reap high profits. But, if economic activity continues to contract, who will borrow?"

John, ever since Bear went down last year, most of the large banks have been trading these markets hard both ways, causing extreme volatility... look at the number of 100+ point days either way we have seen in the past 15 months. Trading has accounted for much of their income I believe, probably much more than lending. Following up on my comments above, I would not at all be surprised to see volatility increase here, with a hard move up in the VIX as equity holders start to reassess their green shoots theories. For every "beat" on analyst estimates for many of the major economic reports, it seems that there is a downward prior month revision quietly slipped out at the same time. When investors finally catch on to the game, they may decide to step back from the markets until a more reliable recovery trajectory is revealed.

Jun 03 09:33 PM