Saturday, May 16, 2015

Keystone's 2-10 Yield Spread Indicator

It has been about one year since the 2-10 spread indicator was posted and explored. There has been no need to once the 2-10 spread was unable to move above 255. This is the magic number Keystone uses to verify that banks will rock and roll higher taking advantage of the spread by borrowing at lower rates and lending at higher rates generating strong profits. Banks are happy with a 2-10 spread above 255 but are sad when the spread is under 255. When the 2-10 spread is under 255, the banks do not have an advantage.

Traders are currently tripping over each other to buy banks as yields rise. The optimism is not justified since the 2-10 spread remains under 255. The 10-year yield is at 2.15% and 2-year yield at 0.54% so the spread is at 161 basis points (215-54).

Higher Treasury yields typically result in the interest-rate sensitive stocks such as utilities, telecom, REIT's and home builders selling off while banks run higher salivating over a steeper yield curve.

At the stock market bottom in March-April 2009, the 2-10 spread was about 200 signaling the ongoing turmoil and trouble with banks. In December 2009, the spread was up to 288 with drunken banksters toasting Chairman Bernanke's QE policies as the yield curve steepened and the wine flowed like water. 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 until briefly sneaking above in December 2013. 

During 2013, the 10-year yield spiked higher and everyone thought the happy banking times were here to stay, and, as typically occurs in markets when everyone is on one side of the boat (higher rates and higher bank stocks), this is where the yields reversed, dropping the spread from above 255 to below 220 in early 2014 then lower.

As per the discussion above, there is no reason for optimism with the banks until the 2-10 spread runs far higher from the current 159-161 bips up to 255 bips.

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