At Arm's Length - Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 06.02.05

The Curve is Flat
or Maybe Not

These are special times in the fixed income market. The Federal Reserve has lowered rates eight times over the last year and that has had some effect, although delayed, on the economy. It is hard to say whether the rate hikes were timely or not, but one thing for sure, they have created a special window for bond traders.

Even if you are mostly unaware of these flattening, steepening, or inverse type curves, they all have a message to convey to the market, most of it for prediction purposes. What one needs to look at are extremely short-term investments such as the two year Treasury as they compare to the thirty year note. Looking in two directions at once allows investors to determine market sentiment.

A flat curve is when the yields on these two types of notes begin to trend in a similar line separated by only several hundred basis points. A basis point amounts to 1/100 of a percentage point. When the curve flattens, as it is currently doing, it is suggesting to the investor that short-term holdings might be as good of an investment as the longer one because the yields are so close together.

Strategist look to this type of curve as one where diversification across the spectrum is not necessary. Simply hold both short and long while keeping notes in the five year and ten year offerings at a minimum. Savvy mutual bond fund managers are best employed to keep this particular strategy straight.

Another significant piece of information can be garnered from this as well. If the yield curve has flattened, chances are the Fed is mostly done tightening and the effect of their efforts have had the desired effect of slowing the economy down enough to make both short and long term holdings more appealing.

A steep curve is usually a good indication that the Fed will likely begin to raise interest rates and eventually rein in what would be considered an easy and accommodative money supply.

You would be correct in assuming that the inverted curve means the opposite. The Fed will likely begin easing their grip on money supply to encourage more interest in short-term growth. Inverted curves offer the short-term investor the biggest bang for their buck but it doesnšt offer a very bright economic picture. Keeping money cheap keeps money moving.

Bond markets will have little else to focus on this week aside from the jobs number. If it comes in higher than the anticipated 175,000 to 180,000, Treasuries could sell of as they did after the French referendum on the Euro. That pushed the dollar briefly higher.

But if that number disappoints, expect a rally. For no other reason than one: almost all of the numbers released over the last month have painted a market in still life. Investors, even the worrisome fixed income types might find this an indication that the marketplace is facing some slowdown in the near future one that might not necessarily be priced into trading just yet. If the Federal Reserve notes from their last meeting, albeit a softened version of the actual minutes, show the group unable to agree, then what will a sudden miss in employment do?

The previous week's articles.

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