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Who Will Benefit From a Steep Yield Curve?

The typical answer is "almost everyone." But that may not be the case this time.

A steep yield curve arises when long term rates are higher than short term rates. The higher, say, the 10-year rate over the 2-year rate or the six month rate, the "steeper" the curve (reflecting interest rates at different maturities) is said to be.

The most immediate beneficiaries are the banks and other financial instutions, because they "borrow short" and "lend long," which now means "borrow low" abd "lend high." The "mother" of all bank bailout programs (before this one), took place in the early 1990s when the Federal Reserve "engineered" a steep yield curve to help banks and savings and loans that had been ravaged by bad mortgages (sound familiar) and bad emerging markets loans (less familiar).

Usually that's a good sign for manufacturing. That means that they can borrow low now, to build new capacity in anticipation of rising demand down the line. The problem is that might not hold today. Rising interest rates basically hurt home owners, especially those of fixed rates, who have to spend more of their money on homes, and less on other items.

But the greatest beneificiaries may be China. They have been selling long-term Treasury bills when rates were lower (and prices higher), and moving the proceeds into shorter-term instruments (raising their prices, but to a lesser degree, because of lesser "duration.") Then they can buy longer term paper at higher rates when it comes time to roll it over.

The moral is, the steep yield curve helps some groups more than others. And these are not necessarily the groups that Washington wants to help.