rffrydr
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Joined: 30 Oct 2005
Posts: 16939
Location: Sunny California
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 Posted: Wed Jan 13, 2010 2:35 pm Post subject: |
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Simons thinks we're gonna get burned on both ends once the sweet spot turns sour. The teeter-totter was leveraged no doubt but we're just coming off (down) a period of high expectations slammed onto rocky employment numbers--just when it hurts most, the dawn of a new year. Time flows at it own pace.
| Quote: | Howard Simons
How Steep Can The Yield Curve Get?
11/12/2009 1:45 PM EST
Tom, the last answer you ever want to hear for the rhetorical question, "How stupid can you get?" is "How stupid do you need?" We seem to be pushing this conversation in this direction for the steepness of the yield curve.
Compared to a month ago, the yields are lower out through five years, with the largest changes occurring at the two- and three-year maturities. They are higher for seven years and longer, with the largest change in the 30-year.
Restated, the curve is steepening from both directions. The artificial push lower at the short end is attracting buyers who seem to feel invulnerable to decreased carry at two- and three years. Rising inflation risk and the prospects for rising currency volatility are pushing the long end higher.
I find it incredible investors are chasing yield at the short end and fleeing risk at the long end. Plant and equipment are financed at the long end, so all of this nonsense at the short end is doing wonders for speculators and nothing for people out there in the real world. |
| Quote: | Howard Simons
Yield Curves
11/16/2009 2:17 PM EST
Well done, Mebane. To get Clintonesque, though, let's ask what we mean by the "short end" of the yield curve. At these levels, it does start to matter.
For a long time, many used the spread between the two- and ten-year Treasury as a shorthand; I use not the absolute spread but the forward rate ratio, the rate at which we can lock in borrowing between two- and ten-years divided by the ten-year rate itself; this normalizes the spread.
As the two-year has been a little sticky on the way down, the FRR has stalled since May. However, if we replace it by the overnight index swap, the strip of federal funds, available to banks, we see the yield curve is shockingly steep. It matters not which tenor of the OIS we use, and as long as the Federal Reserve promises not to raise the federal funds rate, this trade will be open.
I expect, then, to have more and more carry trade funders crowd into ever-short borrowing maturities. I also expect corporate borrowers to shorten their debt structures. If and when the turn comes -- it will come, won't it? -- both borrowers and lenders are going to be wrong simultaneously as short-term rates rise.
A rational carry trade funder might want to lengthen, not shorten, their borrowing right now. |
| Quote: | Howard Simons
Debt And Insurance
12/29/2009 12:34 PM EST
Excellent point, Tom. Let's assume the folks at the Bureau of Public Debt understand the implication of lengthening the weighted average maturity of Treasury debt (if they do not, we are in real trouble). Why would they take this known loss now?
The answer is they are making the classic insurance calculation: Assume a relatively small and known loss now to protect against a large and open-ended loss later. If they extend maturities, they are locking in a strip of forward rates at today's levels and insuring themselves against the eventuality of refinancing at higher short-term rates at that point in the future.
When a large debtor moves to lock in their costs, to switch from floating to fixed, small creditors should take notice. As I said a couple of weeks ago, you have to "come out of the box thinking three." The rise in Treasury rates over the next few years could be of 1970s proportions unless the Federal Reserve keeps on monetizing debt. |
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