CHART OF THE WEEK
Apart from the very last days of 2013, the yield on US treasury bonds with a 10 year maturity has moved above 3.0% last week for the first time since 2011. But there are some differences.
As shown in the chart, in late 2013, the move upwards in long-term yields came from the long-term part of the curve, as represented by the 5year 5year forward rate. Now, movements in shorter-term bond yields have explained the bulk of the move upwards, as the 5 year bond yield is at its highest since end 2008. Therefore, the yield curve has flattened considerably.
OUR ANALYSIS
This move comes mostly from the adjustment of the market’s implied expectations for Fed Fund rates. Six months earlier, Futures were pointing to two cumulative hikes over 2018 and 2019. Today, they are consistent with five hikes, three of which to take place in 2018. It is more in line with what the Fed is saying.
The 5y5y forward rate has been almost unchanged since early 2017. This component is probably more impacted by quantitative easing operations. Indeed, bonds with maturity over 5 years account for 38% of the Fed portfolio but 32% of the public debt. Federal Reserve economists have estimated that the whole QE and maturity extension operations have depressed the 10 year term premium, what investors require to hold a 10y bond vs rolling out shorter-dated bonds over 10 year, by 100 bps.
The accelerating shrinking of the Federal Reserve’s balance sheet should thus lead the yields on longer-dated bonds to increase more, which could lead to a temporary steepening of the yield curve.
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1] The Effect of the Federal Reserve’s Securities Holdings on Longer-term Interest Rates, Brian Bonis, Jane Ihrig, Min Wei, Feds notes – 20 avril 2017
The opinion expressed above is dated 3 May 2018 and is liable to change.
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