The Parabolic Yield Curve

Just what is going on with the US Treasury bond market…?

EVERYTHING depends upon listening properly, writes Gary Dorsch of Global Money Trends.

Of ten people who listen to the same speech or story, each person may well understand it differently – and perhaps only one of them will understand it correctly.

How then should traders interpret the shape of the US Treasury’s yield curve, which has gone parabolic this spring, steepening to its highest level since 2004? It’s not only a US phenomenon, with long-term government bonds now offering sharply higher interest than short-term bonds in Europe and the UK. In Australia, the Treasury yield curve is at its steepest in history.

Not surprisingly, Federal Reserve officials were quick to provide a few explanations. “In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen,” said Fed chief Ben “Bubbles” Bernanke on June 3rd. “These increases reflect concerns about large federal deficits, but also greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings,” he explained.

As the massive shockwaves to the financial markets from Lehman Brother’s collapse in September have subsided, and the once frozen corporate bond market has thawed-out, the panic that caused Treasury-bill rates to briefly fall below zero percent for the first time is a fading memory. Fears of another “Great Depression” of the 1930s have been replaced with cautious optimism over the arrival of “green-shoots” or signs that the global economy is stabilizing from its free-fall.

Alongside the swift recovery of the global stock markets, the US Treasury yield curve has gone parabolic, and the Fed’s propaganda artists are wringing their hands of any culpability. “I personally don’t believe the rise in long-term bond yields is due to inflation fears,” said Dallas Fed chief Richard Fisher on June 2nd. Rather, “the yield curve’s steepening appears to reflect an improvement in the economic outlook, combined with the Treasury’s huge borrowing needs,” he said.

Typically the Treasury yield curve steepens when long-term yields are rising faster than shorter-term rates, and the majority of traders are anticipating an economic recovery, to be followed by a tightening of monetary policy. Conversely, the rare appearance of an “inverted yield curve” (where short-term rates are above longer-term yields) has typically materialized near the end of a tightening cycle, and in many cases, telegraphs an economic recession within 12-to-18-months.

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