Only so much paper can be gobbled up at these levels. We saw the yield on the 10 year Treasury, which is tracked closely by the 30 year mortgage, increase by 25 basis points this week. The government must find a balance between funding the stimulus through fiscal spending and promoting economic growth through monetary easing. The Treasury announced $40 billion in two-year notes and $30 billion in five-year notes to be auctioned off next week. The question is, how much of this new supply is the Fed going to have to purchase themselves in order to keep rates low?
The Curve
Also referred to as the term structure of interest rates, curves show what a specific type of bond is yielding across a range of maturities. The graph below shows yield in percent on the vertical axis and time to maturity in years on the horizontal axis. The white line shows the current Treasury curve and the green line shows it as of 12/23/08.
Notice how the two curves in the graph are different shapes. It may be difficult to see from the graph, but since December 23rd the yield on the 2-year has dropped, 11.5 basis points, (or .115 percentage points), from .915 to .80% while the yield on the 10-year has risen 43.2 basis points, from 2.173% to 2.605%. This shift would be considered flattening.
There are curves for municipal bonds, agencies, etc., but in general terms, “the curve” refers to the Treasury curve. Curves are generally upward sloping, although not always. In theory, investors require higher rates of return in exchange for taking more risk. Simply put, the longer the bond, the more risky it is, the higher the yield, which generates the upward sloping curve.
The area of the curve from the 2-year to the 10-year is considered the benchmark curve. When analyzing the shape, (i.e. steepness or flatness) this is area most concentrated on. I plan on discussing curve shape next week.
Have a great evening.
Cliff J. Reynolds Jr.
Junior Analyst
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