Yield Curve Review And Interest Rate Outlook

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Includes: FLAT, STPP, TBT, TLT
by: Pat Stout

The US treasury yield curve May 18, 2012 to May 25, 2012

Issue

May

25

May

18

change

Bps

1 month 0.07 0.06

+1

3 month 0.09 0.08 +1
6 month 0.14 0.15 -1
1 year 0.20 0.20 -
2 year 0.30 0.32 -2
3 year 0.41 0.42 -1
5 year 0.76 0.75 +1
7 year 1.17 1.16 +1
10 year 1.75 1.71 +4
20 year 2.44 2.40 +4
30 year 2.85 2.80 +5
10y2y 145bp 139bp +6
Click to enlarge

source data: treasury.gov

What is driving the fixed income market: fear or fundamentals?

Some analysts have suggested that longer-term interest rates offer a negative real yield. However, the real yield is an unknown. Should deflation take hold then what looks to be low nominal yield may turn into an attractive real yield. Could this explain the high levels of cash?

Should the market be concerned about deflation?

  • Of late commodity prices have been weak.
  • The stock market has been weak.
  • Worries over Europe.
  • Concern over spending
  • Economic growth worries

Outlook

Expect interest rates to move higher.

A 25bp to 50bp shift higher, across the yield curve, might help reduce deflation fears and at the same time provide some relief to savers and boost economic growth.

The downside to higher interest rates would be increased interest expense paid by the government. However, it might be the only message Congress will understand in attempting to reach agreement on spending and revenue.

Something to think about.

Should deflation take hold then making progress on reducing the burden of debt becomes more difficult. Take a look at the real estate market that has been hit by deflation. How is the debt burden being reduced?

Lower asset prices may result in forced selling, resulting in losses. This in turn lowers revenue leading to more spending cuts leading to less income making debt service more difficult. More spending cuts, etc. Growth requires spending. When was the last time a firm cut spending to create prosperity? If lower spending is the answer, then why has the cost of boards and management increased the past decade?

Performance of selected ETFs/ETNs

ETF/ETN

May 25

Close

May 18

Close

$

Change

FLAT

61.69

61.78 dn $0.09
STPP 36.62 36.64 dn $0.02
TLT 123.40 124.20 dn $0.80
TBT 16.55 16.38 up $0.17
Click to enlarge

Source: Yahoo Finance

Disclosure: I am long TBT.