Tuesday, February 1, 2011

Yield curve slope hits another new high

The spread between 2- and 30-yr Treasuries reached another new, all-time high today of 401 bps. As this chart suggests, it's not unusual for the yield curve to steepen coming out of a recession. This is typically driven by Fed easing, as the Fed attempts to provide more money to help the economy recover, and to compensate for the higher demand for money that usually follows in the wake of recessions. One side effect of a steeper yield curve is that this becomes fertile ground for bank earnings. Today, banks can borrow from the Fed at 0.25% and, if they choose, buy 30-yr Treasuries, thus helping to fund the federal deficit while also earning 3.75% net interest on the trade. If the mark-to-market risk of 30-yr Treasuries (which currently have a duration of 17.4, and thus stand to lose about 17.4% of their value if yields rise 100 bps) is too much, then banks can buy 10-yr Treasuries (which the Fed is supposedly going to be backstopping for the next 5 months, and which have only half as much price risk as 30-yr Treasuries) and pick up 3.25%.

In effect, what this says is that the Fed is greasing the skids for a lot of folks and a lot of banks and businesses. Corporate profits are already close to record highs, so it is not too hard to understand why the equity market is up 25% since the end of August.

The next shoe to drop will be a pickup in inflation. Recall that the CPI rose from a low of 1% in mid-2002, as the 2-30 slope passed 300 bps on its way to 360 bps in mid-2003, to reach a high of 4.7% in Sep. '05.


dave said...

Scott you are talking about a pick up in inflation according to how the government counts inflation.

The rest of us have already seen the rise in inflation, at the pumps and in the grocery store.

Jude used to say that wars were fought over calories, we're beginning to see the result of higher food prices and their impact on the developing world as a result of our weak dollar yet non inflationary monetary policy .

Benjamin Cole said...

Inflation-schmaflation. Yield curve, I don't care.

Bernanke can pour it on, baby pour it on.

Dow over 12k, heading to 13k.

Guys, you will just have to get used to some prosperity.

Inflation is dead.

Some people believe in suffering and asceticism, in honor of monetary rectitude and zero inflation. Suffering is worth it for zero inflation, or, even better, some deflation.

Not me. I believe in prosperity.

Pour it on, Bernanke, pour it on, print money until the plates melt.

The Mississippi is a rivulet next to the Mississippi of money the USA can absorb--remember, we import goods, services, capital and labor. More demand equals more supply, no inflation.

Pout it on Bernanke, let it rip don;t start boogying until the cows come home.

Lori said...


I am not one to believe that charts hold any predictive powers, but 11,000. 8,000. 10,000. 11,000.

13, 14 .10. 9. 8. 7.

10. 11. And once again, 12,000.


There are always heaps of volatility, and trading up over and below round numbers on the indices.

Buy the dips!

Christian S. Herzeca, Esq. said...

benjie babie

some words of advice for you: sell in may and go away!

Benjamin Cole said...


You have lost me.


Perhaps I am too bullish. But I think we are on the cusp of a long bull market, and a global economic boom.

Still not too late to get on the bandwagon.

Lori said...


Look at the ten year chart of the DJIA and or the SPX.

There is always much movement around the big, even numbers.

Short term traders who temporarily trade around these even numbers, they come and they go, but the long term trend is up. Way up.

Benjamin Cole said...

Well, Lori, I hope you are right.

I tend to think there is more to milestone Dow Jones readings than serious economists give credence to.

Many people are not closely connected to the market, but know about where the Dow is. When a milestone is passed, it gives them confidence.

For many investors, even serious investors, gut instinct plays a role. They then look for fancy rationalizations for their gut instincts.

In the next few months, you will find (I hope and contend) more investors feel good in their gut--and that is going to add another long leg onto this rally and economic growth cycle. They will spout fancy arguments for their feelings--but deep down, it is their feelings that count. Milestones count.

Predictions are hard, especially about the future.

But I see boomtimes, baby, boomtimes.

Benjamin Cole said...

Add on:

I have predicted 13k on the Dow this year. I am good with that.

But next year, 2012, we will cross 14k on the Dow, and then into record all-time highs.

That will set up yet another leg on the bull market. When people hear that phrase, "all-time high" they will really get confident.

By then, job growth wil be kicking in--it will be a great year.

Edward said...

What no one metions aside from inflation risk, is that the Fed actions, by artificially weakening the dollar, has produced high food prices worldwide and a resurgence in hunger and even famine. It's disgusting.

Anonymous said...

Scott, good chart and points. What is really scary is that banks are riding the yield curve so more than a few are likely to take a bath on a securities mark to market basis when interest rates do tick up unfortunately. I am not sure who is willing to pay a multiple for risky earnings that rely on the yield curve... - Adrian Meli