Yield Curve Review For May 2012

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

The month of May 2012 saw intermediate and long-term treasury yields decline from 3 to 46 basis points. Back in the month of August 2011 treasury yields declined from 10 to 59 basis points. The common thread helping send bond yields lower has been talk over a debt ceiling battle.

The economic weakness seen in the second estimate for first quarter 2012 GDP, which came in at 1.9% versus the advanced estimate of 2.2% (according to the Bureau of Economic Analysis), and other more recent economic releases, might be a result of the August 2011 debt ceiling battle. This is if one believes that actions of Congress affect the economy with a multi-month lag.

Issue April 30

2012

May 31

2012

Change August 31 2011 Change

Aug-May

1m 0.07 0.03 (4) 0.01 2
3m 0.10 0.07 (3) 0.02 5
6m 0.15 0.14 (1) 0.05 9
1y 0.20 0.18 (2) 0.10 8
2y 0.27 0.27 0 0.20 7
3y 0.38 0.35 (3) 0.33 2
5y 0.82 0.67 (15) 0.96 (29)
7y 1.33 1.03 (30) 1.56 (53)
10y 1.95 1.59 (36) 2.23 (64)
20y 2.73 2.27 (46) 3.19 (92)
30y 3.12 2.67 (45) 3.60 (93)
10y2y 168bps 132bps (36) 203bps (71)
10y5y 113bps 92bps (21) 127bps (35)
30y1y 292bps 249bps (43) 350bps (101)
2y1y 7bps 9bps 2 10bps (1)
Source data: www.treasury.gov
Click to enlarge

Where do yields go from here?

If deflation takes hold then the nominal interest rates may stay steady or decline somewhat. However the real interest rate would increase. The winners might be bondholders, with stockholders enjoying less profits and dividends.

Fear is becoming more of a concern. Fear may result in money being stockpiled making it more difficult to grow the economy. The IPO of Facebook (NASDAQ:FB) hasn't helped investor confidence.

What will the Federal Reserve do?

A better question might be what can the Federal Reserve do. It is tough to say. Buying bonds and sending yields lower, means investors need to save more to generate the same level of income. Maybe that helps explain the large cash balances. The Federal Reserve might be pushing on string.

In January 1990, $100,000 invested in the 10-year treasury would generate yearly gross income of roughly $7,900. Today it would require nearly $500,000 invested in the 10-year to produce the same level of interest income.

In January 1990, $100,000 invested in the 30-year would generate yearly gross income of roughly $8,000. Today it would require nearly $300,000 invested in the 30-year to produce the same level of interest income.

Is the bond market signaling deflation or are the bulls just squeezing the bears? Or maybe the US will go the route of Japan with decades of low interest rates.

It is ironic that big money is making it easier for the government to spend by pushing treasury yields lower, while making other businesses pay a higher interest rate on borrowings. If the big money would support its fellow businesses then maybe everyone could come out a winner. Greater profits, higher stock price, better employment, etc. Oops, the loser in that might be the bondholder if things get too good.

A review of selected ETFs/ETNs

TBT is the ProShares UltraShort 20+ Year Treasury and should benefit from increasing interest rates.

TLT is the iShares Barclays 20+ Year Treasury and should benefit from declining interest rates.

FLAT is the iPath US Treasury Flattener and should benefit from a flattening of the 10y-2y yield curve.

STPP is the iPath US Treasury Steepener and should benefit from a steepening of the 10yr-2yr yield curve.

Issue

April 30

2012

May 31

2012

August 31

2011

TBT 18.51 15.45 25.45
TLT 117.32 127.60 107.03
FLAT 59.56 62.79 54.63
STPP 38.84 35.35 43.94
Click to enlarge

Source: Yahoo Finance

Disclosure: I am long TBT.