Tuesday, October 14, 2014

Treasury 2yr-10yr Test Support. What Fed Patience Means...

Someone requested I review the Treasury 2yr-10yr yield curve. This spread has a double bottom (or in candlestick analysis a Tweezers Bottom) at 183.1 basis points. The spread dove from 205 basis points wide a month ago, finding this spread now a little stretched. It will be interesting to see if it pushes below 183 to give a hard test to a longer time frame support at 180.

The expected nature of the Fed tightening when it arrives as being very slightly sloped is having an impact on this spread. In historic cycles we could price a lot of Fed 'accommodation removal' within the first two years. Currently however, many suspect the Fed would be limited to 25 basis points of fed funds firming every other FOMC meeting or 4 time a year...at least initially. If the Fed lifts policy rates initially in mid-2015, there remains only 1.25yrs of today's 2yr available for firmer Fed policy. At the pace discribed above that limits policy firming within the next two years to about 150 bps. Unless one believes the Fed will find itself well behind the curve in removing accommodation within the next year, the prospects for this 2yr-10yr Treasury curve to flatten is currently limited.

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