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Minyan Mailbag- Flattening Yield Curve

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

Hi John,

You have repeatedly pointed to the shape of the yield curve as implying a substantial weakening of the economy. Could an alternative explanation be related to the following consideration?

I am hearing that the Department of Labor is close to requiring pension plans to decrease the gap between their assets and liabilities as they currently are substantially short duration. If that change were to occur, I am hearing that there would be a stampede towards buying longer duration assets which is likely to lead to an inversion of the yield curve between 10 year treasuries and 30 year Treasuries. Hedge funds have supposedly started positioning themselves for that change, which explains the flattening we have seen recently.

I would appreciate your thoughts on this alternative theory for the flattening yield curve.

Thank you,
Minyan Paul Aris



Paul,

That is close, but not perfectly accurate on my comments.

I think the short end is being raised because of the imbalances and excess dollars that are circulating. The Fed is gingerly trying to extract all the liquidity they have pumped into the markets.The Fed is being forced to raise short term rates to placate foreign holders of dollars. The long end then "feels" that this could weaken future growth.

That thought process is subtly different. It implies no choice by the Fed, which is more sinister than just saying that the curve "is implying a substantial weakening".

I also did say there was some buying (support) for the long end from GSE's. I think you are also right about pensions...they are starved for yield and have increased risk everywhere to close their liability gap. This includes going longer duration (and buying stocks). I wrote about this too.

Hedge funds also I have no doubt have bet on the flattening, all based on the above thoughts.

Regards,
Prof. Succo

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