Is Yield Curve Analysis Even Useful Anymore?
By Alex Bernal Dec 24, 2012 11:00 am
A trader looks back at past yield curve signals and the popular delusion of the US long bond.
October 2008: Helicopter Ben Shifts the Printing Presses to Warp Speed? Zero Interest Rate Policy (ZIRP) – Short End Is Anchored at 0% -- The emergency rate cuts orchestrated by the Fed and implemented on a global scale by the major central banks aimed to unfreeze the global credit market. This was the start of the battle against the deflationary death spiral, which was during my first few months of trading Treasuries; I consider it being baptized by fire; "Eurodollar Blow Out," "10 yr. Gone Special," and "Cash Is King" very much dominated the vernaculars at the time. Meanwhile the ends of the yield curve were marching in completely opposite directions.
March 2009: Yield Curve Bull Flattener with a Hump -- The psychological factor at the bottom was critical as the market reversed to its sentiment extreme: "We are all gonna die!" and "All hope is abandoned" dominated the psychological environment. At the time, the 10-year note was at record low yields and seemingly had a restless permanent bid. Very irregular "humped" profiles of the curve also emerged as the different parts wandered aimlessly with low correlations.
April 2010: Normalized Yield Curve, but Still Anchored at 0% – Liquidity Trap Begins -- I still remember that for three weeks straight on CNBC, they were asking if this last surge in that stock market in March '09 from the 666 lows was real and nobody believed it. In hindsight, it is now easy to see, but hard not to have been engulfed by the panic at the time. A generationally steep yield curve, extreme bearish "the end is near" sentiment, and oversold technical readings off the Richter scale were signs that the bear market might be over. Bear market rallies are said to be the most violent because of the massive short covering by highly leveraged hedge fund managers who in desperation are trying to fade any upward moves to ride perceived dead stocks back into the ground. But Bernanke and the Fed were committed to holding the interest rates at zero "forever," which started to penalize those hoarding cash. Fund managers were pressured by the dismal performance (and losses from 2008) to chase performance and were forced to overweight stocks (to save their jobs). Also note in this chart that the market was at a swing high and had no signs of inversion or even high levels of volatility across the curve.
Long RRPIX and short TLT Call Spreads (related securities).
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