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Is Yield Curve Analysis Even Useful Anymore?


A trader looks back at past yield curve signals and the popular delusion of the US long bond.


June 2012 Low – Pancaked Even Lower? -- As you can clearly see, there is a flattening starting to occur with every drop of the stock market, pushing real interest rates even more negative. This makes ownership of equities, even ones with little or no profits, even more attractive.

September 2012 – Most Recent High – No inversion. No yield curve signals.

Today – The big question: Is yield curve analysis even useful anymore? If all these rates are fictitious, how can we visualize and measure any movement in the capital markets?

How much purchasing power of our dollar will vanish before M2 spills over the floodgate and rushes back into the economy? To me, the recent price action of the metals complex confirms that inflation is looming and a Frankenstein-like return could be close at hand. James Turk of concurs and explains it well in this video.


Today: Where Can We Go From Here?

The chart above gives us an even more detailed view of the yield curves movement over the last 10 years. The only question on everyone's lips is: Where do we go from here? Or better yet, where can we go?

The "nuclear option" that Bernanke is trying to achieve is outright complete monetization of the debt and super-duper stimulus through sustained negative real interest rates. The Fed is issuing as much debt in all times frames, as much as it can get away with as indicated by the shape of the curve and the continued successes at monthly Treasury auctions. Fun fact: The laughable "debt ceiling" was created in 1917 and has since been raised 104 times. Why not just raise it to $100 trillion and give us some time before we bump our heads again?!

I personally think the critical point of no return has come and passed, but we are being hypnotized into not seeing it. This mirage is currently in the form of curve flattening and will be painted as the telltale sign of "recovery." Only those who see through the facade will realize that its true identity will be unveiled by a sparked crisis in confidence, otherwise known as a re-awakening of a monetary Frankenstein known as Inflation. I believe that double-digit interest rates are on the horizon. The MOVE Bond Volatility Index will be the next big ETF. And the 30 yr. bond will collapse in price soon.

If we are in the final innings of a debt super-cycle, what is the catalyst that will end the game? And how will we see it forming if the short end is dead?

Because of Fed interest-rate pegging, all of the rates and spreads between different quality bonds are a mirage. The yield curve is not market driven and none of the free market forces seem to matter anymore. The price of money is dictated by the powers that be and Wall Street has turned into a killer shark algo swarm merely front-running any next move. One other area of fixed income that can be useful this time around are the high spread between Treasuries and high yield bonds. They have been the warning signal for large treasury market moves in the past. Keeping track of the SPDR Barclays High Yield Bond (NYSEARCA:JNK), iShares iBoxx $ High Yield Corporate BD (NYSEARCA:HYG), and Market Vectors Intl High Yield Bond (NYSEARCA:IHY) are a way to watch this.

So I guess my final thesis is that since the front end of the curve is set in stone to stay at zero we might not get a final Treasury curve inversion to signal the next bear market. I've heard unconfirmed reports that the Fed already owns over 27% of all duration Treasuries and is increasing its holdings by over 10% per year. One thing I do know is that when this game does end, the move up in rates for the long end of the curve will be legendary.

Editor's note: This article and full disclaimer originally appeared on investing and economics site, See It Market.
Long RRPIX and short TLT Call Spreads (related securities).
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