Yield Curve Spreads, QE3 and the U.S. Debt Crisis

Quick question, are U.S. Treasury yields higher or lower today that they were in early September? We are in the midst of a government shutdown (the sky has NOT fallen - that says a lot about federal government largesse) and we are staring down the possibility of a technical default by the United States. One would think yields would sky rocket while prices plummeted. Right?

Wrong.

Yields are significantly lower than the high prints of 5 September 2013.

	15-Oct-13	5-Sep-13	Difference
2 yr	0.35%	0.52%	-0.17%
5 yr	1.44%	1.85%	-0.41%
10 yr	2.72%	2.98%	-0.26%
30 yr	3.78%	3.88%	-0.10%

Source: U.S Treasury, Bloomberg

Higher yields equal higher risk premiums. But yields are lower now? The markets feared the end of QE3...a massive technical bid in the U.S. Treasury market. With the Fed's firm commitment to extend QE3 the market is not concerned with the bid going away, just slightly perturbed that the Washington politicians are acting like middle schoolers. 

The bottom line is that the market does not take the political brinksmanship seriously. The DJIA is off 0.30%, The S&P 500 is off 0.20%, the WSJ Dollar index is up slightly and U.S. Treasury yields are higher by 3 - 5 basis points.

Trade Weighted Dollar Index

So what does this mean for the bigger picture? The current media fueled political cat fight does not address the bleak underlying fundamentals of U.S. fiscal policy. These policies caused significant dollar depreciation. The front end of the yield curve is significantly steeper over the last 12 months. The U.S. Treasury futures 2s5s yield curve spread is 50 basis points steeper in the last 12 months. 

U.S. Treasury Futures 2s5s Yield Curve Spread

The 30 year secular bull market in bonds will end. With real rates of return on the 10 year treasury note at 0%, there is little room for income buyers or total return buyers to drive prices up and yields lower. The composition of the demand curve for U.S. Treasury securities has shifted dramatically in the last 20+ years. It is now dominated by central banks, which are not motivated by profit maximization. This topic will be covered in depth in a future blog post.

Yield curve spreads provide both a trading and diversification opportunity that is independent of outright interest rate levels. Keep yield curve spreads front of mind as you strategically position your portfolio across equites, credit, FOREX and commodities. CurveTrades makes it easy and provides valuable insight.

RIDE THE CURVE!