U.S. Treasury yield curve spread analysis
There is increased attention on the level of U.S. Treasury interest rates now that rates have moved up and are nearing their highest levels from last year. The recent rise in rates from the current round of QE2 (or Credit Easing) from our fearless leader OB1-Bernanke and his band of freedom fighters is playing out in a similar manner to the first round of QE/Credit Easing. This should not surprise anyone that tracks interest rates. One of the ways we analyze the steepening UST yield curve is to identify reasonable limits to nominal rate levels. Remember, while the nominal level of interest rates is what grabs business news headlines, the moves in interest rates are driven by their relationship to other rates. In fact, this is why QE2 was enacted in the first place. Chairman OB1-Bernanke commands the Fed captains to purchase ‘longer-term’ interest rates, which in practice means 90% of the purchases will be between 2yrs and 10yrs. This the ‘sweet spot’ since rates below 2yrs are already near 0 and rates above 10yrs will be affected directly by the level of rates on these ‘longer-term’ maturities. Of course, anyone that follows interest rates knows that while short-term rates are directly controlled by Fed action, longer-term rates are driven by a variety of forces including macroeconomic forecasts. Regardless of what the FOMC does in their purchasing, they can not directly control long-term (more than 10 yrs) rates. If economic growth prospects improve – which they have – longer-term rates are likely to go higher to create a steepening yield curve. When economic growth prospects diminish – as they did during the euro sovereign debt crisis last summer – that steepening gets unwound, often resulting in lower long-term rates.
Late fall we anticipated a steepening yield curve in response to the $1.5 trillion in fiscal stimulus ($868b) and QE2 monetary policy support ($600b). The chart below illustrates some of the curve steepening spreads we monitor. As you can see, all UST spreads have widened significantly (steeper yield curve) since fall 2010. We are now nearing the levels from early last year – just before the euro debt problem. There are limits to how high the curve can steepen in our view, which we outlined in our January edition. The 30yr-3m appears to have another 25 basis points or so before it reaches the all-time record set last year. However, the 30yr-2yr has already reached a record level of 400 basis points – higher than the level it reached in 2010. It appears the bulk of this move in long-term rates has now occurred. Although some additional widening is possible, it will be a challenge for long-term rates to move substantially higher from here until the Fed is prepared to commence a rate hike campaign – which we do not expect anytime soon. The poor job creation figures and record low level of inflation indicate a ZIRP (zero interest rate policy) will remain in effect for some time.
2010 Yield Curve Spreads
2011 YTD – Yield Curve Spreads
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