Thursday, January 12, 2017

YC2YR 2-10 Treasury Yield Spread (Yield Curve) and XLF Financials ETF Daily Charts; Correlation Breakdown

Traders have been flocking into financials like madmen over the last three months. As the yield curve steepens, the banks have an easier time at making money. The 2-year Treasury yield is at 1.17% and the 10-year yield is at 2.34% so the 2-10 spread is 117 basis points as shown in the YC2YR chart. The 117 is actually another tick lower than the 118 in the chart showing how the yield curve continues to flatten in this near term.

The yield curve began steepening in August and September so the banks developed a little bit of life. In October, the yield curve steepens more quickly and the XLF catches a strong  bid. When Trump wins the election on 11/8/16, yields catapult higher and the yield curve steepens as shown by the 2-10 spread spiking from 110 bips to 124 bips. The sharp move creates a stampede into the banks. Traders proclaim that yields will rise here on out since Trump promises stimulus and infrastructure spending, lower taxes and reduced regulations which should fuel inflation.

Investors are tripping over each  other to buy the banks. Keystone's neighbor, Frank Fafoshnik, took his entire life savings down to the broker in town and bot financial stocks like the talking heads on television suggested. Everyone is going long the banks back-slapping each other and telling each other how smart they all are. The yield curve continues to steepen well into December until Christmas and the wine is flowing like water.

But from Christmas to present, the yield curve is flattening as shown by the chart dropping from 134 basis points to 117 bips as this is typed. A smaller YC2YR number shows how the gap between the 2 and 10-year yields is narrowing which flattens the yield curve. The spread may collapse back down through that gap-up area after the election.

The financials, however, are still partying like its 1999 ignoring the now-flattening yield curve. Today they are showing softness as traders and investors review the behavior of the yield curve as explained above. Either the banks must roll over to the downside to respect the  yield curve, or, the 2-10 spread above will move higher again reflecting a steepening yield curve to agree with the continued strength in the banks. Bank earnings hit the tape in the morning and will provide a decision. Lots of folks will have egg on their faces if the banks roll over from here along with a flatter yield curve. Frank will be eating franks and beans. 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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