Sunday, May 15, 2016

YC2YR Yield Curve Weekly Chart 10-Year Yield Minus 2-Year Yield Record 9-Year Low

A flattening and/or inverted yield curve (where the 2-year yield rises above the 10-year yield) are harbingers of a recession ahead. The 2-10 yield spread is a useful indicator in assessing whether the yield curve is steepening or flattening. Traders love a steepening yield curve since it typically occurs in conjunction with an improving and robust economy. Financials are bot since the larger spread makes it easier for banks to make money on the rate differences; borrowing low and lending high. When the yield curve steepens, you will typically see the banks rallying and visa versa, as the yield curve flattens, the banks are beaten.

The 10-year yield is 1.70% and the 2-year yield is 0.75% (1.70-0.75= 0.95; 95 basis points). The yield curve has not been this flat since late 2007, nearly 9 years ago; call it 8-1/2 years if you want to be exact. When the yield curve was steep in 2009 into 2011, the banks celebrated but the red lines show the negative divergence, overbot conditions and rising wedge pattern that created the spank down in the spread.

Yields are moving sideways for a few years. The inflation the Federal Reserve is trying to create via the obscene Keynesian money printing remains on a milk carton (missing). Global disinflation and deflation continue to rule the roost around the world. There is a huge gap in 2007 at 84-87 bips; big enough to drove a truck through. Thus, the spread is on an island for the last 9 years (above 87 bips) and if the spread drops to say, 90 bips then immediately collapses back down through the gap to 84 bips and lower, that would create an island reversal pattern. If price simply comes down to fill the 84-87 gap that is termed a gap-fill.

Another scenario is the spread stopping in this current 87 to 95 bip range, building a base, and then moving higher staying on the island created by the gap-up move in 2007. The green lines show a falling wedge, oversold conditions and positive divergence with the indicators, thus, the spread should base going forward on the weekly basis and trend higher. The question is where does it print the low spread; either now in the 87 to 95 bip range, or, if 87-90 fails, the 84 and lower will likely occur very fast.

Fed Chair Yellen holds the answer. If there is a threat of a rate hike occurring sooner rather than later (market participants do not expect a hike this year and those that do say December may be a possibility; the Fed says two hikes are on the table this year), the 2-year yield will spike higher and that may flatten the yield curve placing the gap fill and perhaps much lower spread numbers on the table. The standard expectation for a rate hike cycle, however, would be that all yields are moving higher with the long end rising faster and the yield curve steepening making for a happy financial sector and overall economy. Seven years of obscene central banker Keynesian policies, however, have distorted markets and destroyed price discovery so no one really knows what any asset is truly worth anymore.

After the BOJ went into negative rate territory, money outflows from Japan are increasing and that capital is being exported to the United States. The dough is buying the long end of the Treasury curve so the higher bond and note prices drive the yields lower. This drama is occurring on the long end (pushing yields lower) while Yellen is steering the 2-year yield. If a rate hike remains unlikely this year, the status quo of sideways moves in yields is likely. 

The Fed decision on rates is 6/15/16, then the Brexit vote 6/23/16 then the Spanish elections 6/26/16. Puerto Rico needs a $2 billion and more bailout package by 7/1/16 to simply keep the sinking ship afloat (the troubled territory is mired in over $70 billion in debt). The US republican and democrat conventions are in July with tempers increasing as the temperatures increase. The US may be impacted by riots and social unrest in July. A lot of drama will hit the markets over the next 7 weeks. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.

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