Friday, February 5, 2010

What is the bond market saying?

I cannot get over the short end of the yield curve.

The market is sending very scared signals. Short term (1-3months) rates are almost zero, and the 2 year note yields about .77%, WAY off it's levels of the past five years, while the 10 and 30year are largely flat with those levels. Clearly, the bond market is crowding into the short end as they fear rising rates (the longer your bond's duration, the more its price will fall as interest rates rise). Part of the reason for such low yields on short term debt is the deliberate actions of the Fed, but to what extent I do not know.

A smart friend of mine in the fixed income world shared his thoughts in an email:
"Interesting huh. The decline in the 2 year is clearly following the feds zero interest rate policy and the perception of low rates for a long time. To not bring down the long end means expectations for higher rates in the future, so really a recovery and a fed that will have to raise rates OR a government that will need higher rates to rollover its debt. Either way it is not yet saying a deflationary environment, but more like a lackluster long term recovery story.
Its interesting.. 10ys and 30’s spiked a while when Greenspan was raising rates in 05… but alas that blew up with the 2007 credit crunch.
Many people fear inflation and what they should be afraid of is deflation. Much much worse."
Copyright 2010 AlphaNinja

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