Sunday, June 23, 2013

Keystone's 2-10 Yield Spread Indicator

Note and bond yields jump higher so the interest rate sensitive sectors are hit such as utilities, telecom and REIT's.  At the same time a steepening yield curve benefits banks so they receive a bid although late in the week the luster was coming off the financial rose.  Since the yield curve is showing signs of life it is time to take a look at Keystone's 2-10 Yield Spread Indicator. The magic number is 255. When the spread between the 2-Year Note and 10-Year Note is over 255 basis points, the yield curve is sufficiently steep to provide the banks with hefty profits. Under 255 basis points and bankers have nothing to be happy about since the economy is in a slow growth environment with lackluster business activity, like now. 

At the market bottom in March-April 2009, the 2-10 spread was about 200 signaling the ongoing turmoil. In December 2009, the spread was up to 288 with drunken bankers toasting Chairman Bernanke as the yield curve steepened. The spread was 270+ into summer 2010 when another deflationary scare occurs dropping the spread under 255.  Chairman Bernanke saves the equity markets with QE 2 in August 2010.  In early 2011, the spread is back above 255 favoring the bankers but then in the summer of 2011 the spread falls under 255 and remains under ever since. What is the spread now?

The 10-year yield climbs higher all last week up to 2.54%.  The 2-year yield is 0.37%. The spread is 254-37 = 217.

The 217 remains 38 points under the 255 level so the bankers are not yet happy. If the 10-year yield climbs another 35 or 40 bips to make the bankers happy, that is a 10-year yield around 2.90%-3.00%. So put this one on the watch list moving forward. The talk and bullishness around banks is not yet justified and likely would not be until the 10-year climbs to 3% and higher, so the early giddiness appears misplaced. Further, the financial charts are negatively diverged pointing to trouble ahead for the banking sector.

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