Flatter My Yield Curve To Thee
That sell-off was accompanied from May 2 to December 24, 2013, by a bearish flattening of the yield curve as measured by the forward rate ratio between 10 and 30 years (FRR10,30). This is the rate at which we can lock in borrowing for 20 years starting 10 years from now, divided by the 30-year rate itself. The more this FRR10,30 exceeds 1.00, the steeper the yield curve is. This bearish flattening had been quite the norm following the start of Operation Twist back in August 2011.
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Given the strongly inverse relationship between the FRR10,30 and 30-year yields, the bullish steepening between December 24, 2013, and March 13, 2014, should have come as no surprise. However, what happened afterward was, unless you start accounting for haven bids. Thirty-year yields continued to fall, but the FRR10,30 flattened bullishly. This is an unmistakable sign of strong and risk-seeking behavior at the long end of the yield curve.
Who might be the usual suspects? Please recall that March 13, 2014, came immediately after a large and otherwise mysterious drop in securities held in the Federal Reserve's custody holdings. As this came after the first phase of unpleasantness in the Ukrainian situation, speculation emerged quickly that Russia was the seller so as to avoid a potential freezing of assets. Such speculation emerged one month later (albeit from me) that Russia was a major seller of US equities as well.
If Russian money flowed back into Treasuries or if flight capital from elsewhere flowed into Treasuries, it seemed to be going into the long end of the yield curve, the last refuge of positive real returns. Even now real rates are negative out to six years and 10-year real rates are a paltry 0.40%. You might as well grab for the 1.11% real-rate brass ring at the 30-year horizon.
I think this trade is coming to an end for those of you looking to buy the long end of the yield curve, either directly with bonds or through an ETF such as the SPDR Barclays Long Term Treasury ETF (NYSEARCA:TLO). The FRR10,30 bottomed on April 24, 2014, and unless 10-year Treasuries can break resistance at 2.55%, the next steepening of the yield curve will be a bearish one. The world is a scary place, but it doesn't have an infinite supply of profit-indifferent flight capital.
Industry Group Impact
If you're wondering how this little tale affected various industry groups, the answer is: not much. I compared the returns for 144 industry groups from December to March and tested to see which ones changed at a 90% confidence level afterward. Only eight did, and there was no real pattern involved. Twenty-five groups remained unchanged at the same 90% confidence level. Restated, the stock market shrugged as the long end of the Treasury market rallied.
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