Wednesday, March 11, 2015

Treasury 5-30 Often Flattens Before and After Fed Hikes



I have been a steady follower of the Treasury 5-30 yield curve spread and have since early-2014 projected a stronger flattening than forwards had priced.  Right now the spread trades to 108 bps and not far from the recent low of 102. 

There have been several instances since January where this yield spread has moved temporarily wider, though in each instance the advance stalled at lower levels.  The latest of these advances came from near  current levels and reached only to 116.  The consecutively lower stall points suggest that momentum cannot build.  Therefore, a move lower is likely soon enough. 

The enclosed chart examines the last three instances where the Fed moved policy rates higher and the response seen in the 5-30 yield spread.  The table below illustrates  fed fund rate move dates and levels of Treasury 5-30 Yield curve:

Date
FF (%)
5-30 Spread (bps)
Feb 1994
3.25
92
Dec 1994
5.5
1
8 months
2.25
-91
Jun 1999
5
36
Apr 2000
6
-60
10 months
1
-96
Jun 2004
1.25
152
Feb 2006
4.5
-9
20 months
3.25
-161
Average


12.6 months
2.17
-116


Based on these averages, one could make an argument for the Treasury 5-30 yield curve spread to move from roughly 108 now to -8 bps by June of 2016.   



We note with interest that the low point on the 5-30 spread came twice within a month of the last policy rate move.  In 2006, the low point on the 5-30 spread came about 4 months earlier than the last rate move.  This discussion is for illustrative purpose and we would not recommend relying too heavily on recent averages as a guide to where the yield curve will move to in the next months.  However, there are very compelling reasons aside to recognize that the long end of the treasury curve can maintain lower yields for scarcity and foreign v. domestic yield spread reasons while the influence from any policy  firming is directed up the curve. 







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