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How the Bond Markets React 06.02.05
The Curve is Flat
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 doesnąt 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?
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