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The Mystery behind the Parabolic Yield CurveGary Dorsch Everything depends upon proper judgment. Of ten people who examine the same chart, or listen to the same speech, each person may well understand it differently - perhaps only one of them will understand it correctly. How then should traders interpret the shape of the US Treasury yield curve, which has gone parabolic in recent weeks, steepening to its highest level since 2004? Similarly, in Australia, the Treasury yield curve is at its steepest in history. Not surprisingly, Federal Reserve officials were quick to provide a few explanations. “In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen,” said Fed chief Ben “Bubbles” Bernanke on June 3rd. “These increases reflect concerns about large federal deficits, but also greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings,” he explained. As the massive shockwaves to the financial markets from Lehman Brother’s collapse in September have subsided, and the once frozen corporate bond market has thawed-out, - the panic that caused Treasury-bill rates to briefly fall below zero percent for the first time is a fading memory. Fears of another “Great Depression” of the 1930’s have been replaced with cautious optimism over the arrival of “green-shoots,” or signs that the global economy is stabilizing from its free-fall. Alongside the swift recovery of the global stock markets, the US Treasury yield curve has gone parabolic, and the Fed’s propaganda artists are wringing their hands of any culpability. “I personally don’t believe the rise in long-term bond yields is due to inflation fears,” said Dallas Fed chief Richard Fisher on June 2nd. Rather, “the yield curve’s steepening appears to reflect an improvement in the economic outlook, combined with the Treasury’s huge borrowing needs,” he said. Typically, the Treasury yield curve steepens, when long-term yields are rising faster than shorter-term rates, and the majority of traders are anticipating an economic recovery, to be followed by a tightening of monetary policy. Conversely, the rare appearance of an inverted yield curve, (short-term rates above longer-term yields), has typically materialized near the end of a tightening cycle, and in many cases, telegraphs an economic recession within 12-to-18-months.
The steepening of the US Treasury yield curve is one of the great mysteries in the marketplace today. The US Treasury’s 10-year note is yielding about +255-basis points above the 2-year yield, which is somewhat of an anomaly, since such a wide spread would normally be associated with expectations of a V-shaped recovery for the US-economy. Moreover, the Fed would typically send hints to the markets, that it’s ready to start draining excess liquidity from the money markets, in order to keep inflationary pressures in check. But on May 24th, Fed deputy Donald Kohn denied the Fed would raise interest rates anytime, arguing that ideas of a V-shaped recovery are far-fetched. “The US-economy is only now beginning to show signs that it might be stabilizing, and the upturn, when it begins, is likely to be gradual amid the balance sheet repair of financial intermediaries and households. As a consequence, it probably will be some time before the Fed begins to raise its target for the federal funds rate.” However, Kohn’s remarks failed to stop the bleeding in the Treasury bond market, and yields jumped to their highest levels in seven-months. The Fed’s experiment with nuclear “Quantitative Easing,” (QE) is backfiring. The borrowing costs that Bernanke & Company aim to drive lower, are instead, moving higher, despite the Fed’s stated commitment to buy $300-billion of long-term Treasury notes through August, with US-dollars rolling off its electronic printing press.
So far, the Fed has bought $150-billion of Treasury debt under the QE framework, but that amount pales in comparison to the $2-trillion supply of new debt that is swamping the credit market this year.This week, the Treasury is auctioning $35-billion in three-year notes, $19-billion in 10-year notes, and $11-billion in 30-year bonds. Given the massive deluge of new supply, the Fed has been unable to manhandle the Treasury market. Its original goal of enforcing a lid on the benchmark 10-year yield at 3.00% has been blown to smithereens. The Fed tried to follow the blueprints of the Bank of Japan (BoJ), which uses strong-arm tactics in the $8.5-trillion Tokyo bond market, through skillful manipulation and jawboning exercises. Japan’s 10-year bond (JGB) yield has been locked within a tight range between 1.15% and 2.00% for the past ten-years, even through the inflation boom cycle that carried crude oil to $145 per barrel last year. Now that the Fed is halfway through its money printing binge, it may soon have to decide whether to up the ante, by ramping-up its Treasury debt purchases to as much as $1-trillion. But of course, the big risk with massive QE overdoses is that the gambit could end-up crushing the value of the US-dollar and intensify inflation fears that are festering in the bond market, pushing yields higher. In other words, massive money printing could send crude oil prices to $100 per barrel. To read the rest of this article, click on the hyperlink below: http://www.sirchartsalot.com/article.php?id=111 Jun 10, 2009 321gold Ltd |
