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Treasury Yield Curve

July 26, 2018

The Yield Curve refers to the arc of a graph showing Treasury rates starting from a month until 30 years. Usually rates are lower for the earlier periods and as the periods increase the rates get higher. So, a normal curve would show an upward trend.

The reason longer periods have higher rates is because of the risk. Any investment for a longer period is usually riskier than for a shorter period. For example, lending money for 10 years should command a higher rate than when you lend it for one year. There are many things that could occur in the additional nine years. In the case of Treasuries, there is no risk of default, but there is a risk you might need the money sooner, i.e. before maturity, and you would need to sell the bonds. In that situation, you would only receive what the market deems to be an appropriate price and that could mean selling the bonds at a loss. Another risk is that a better opportunity could arise that you would need to pass up since your funds are already invested, and yet another is that rates could go up causing you to forgo those increases since you already invested your funds. There are many other reasons, but the point here is that the longer the period the greater the risk.

Since we are talking about financial assets, risks need to be compensated for, and the way that works is with higher rates for longer periods. Traditionally the longer the period the higher the rate. However, we are in a period where there is very little compensation for longer periods. As of Monday the 1 year rate was 2.42%, 5 year rate 2.83%, 10 year 2.96% and 30 year 3.10%. To me, this shows very little difference in the rates and if we were to chart this on a graph the arc, or curve, would be pretty flat and it would be called a flat yield curve. If perchance we had lower long term rates than shorter term rates, the yield curve would be inverted. By way of comparison the rates for those periods on July 1, 2008 were 1 year 2.38%, 5 year 3.62%, 10 year 4.01% and 30 year 4.55%. And as an FYI the Jan 2, 2009 rates were 1 year .40%, 5 year 1.72%, 10 year 2.46% and 30 year 2.83%. Notice the big drop in that last six month period. This represented a flight to safety.

A flat yield curve can mean a lot of things. Lower long term rates, which we’ve had for quite a while now, indicate to me an uncertainty and doubt about the future and whether those that typically borrow long term – businesses and governments engaging in long term building – are holding back. This is usually because the expected return on investment (ROI) is not that much greater than the cost to borrow, or other non long-term opportunities, such as companies buying back their own stock. It also suggests an expectation of low inflation and low demand. Shorter term rates, to me, are “manipulated” by what the Fed suggests it would do, and what it likely would do. The Fed on some manner controls short term rates, but it has no effect on long term rates except by those that react to its periodic “pronouncements.” I’ve written about the Fed ad nauseum so won’t get into that right now. Also factoring into the rates and business investments are inflation expectations, employment levels, savings rates and debt levels, the equity markets, economic activity, global security, expected growth, supply and demand, taxes, tariffs, government actions and confidence in such actions.

Treasuries are considered a bell weather investment that are risk free from default, and are used as the guideline for any discussion on interest rates. However, there are many other ways to invest for fixed income and with many other issuers. This blog was meant to illustrate the phenomenon we are close to experiencing of a flat yield curve.

This blog represents my opinions only and any suggestions of actions are unintended. This has been prepared solely for educational purposes. Enjoy! Ed Mendlowitz

P.S. if you want to check out Treasury rates – current and historic – here is a link: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

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