Another Look at the Yield Spread

Values Up, Ownership Down
June 1, 2016
Voodoo Math
June 3, 2016

If you watch CNBC, you may have heard Rick Santelli yelling about the flattening of the yield curve … and how this is a BIG PROBLEM!  Rick suggested the fact that narrowing of the spread between the 10-year and 2-year Treasurys could indicate a recession is coming.   Soon!

Not really.  Take a look at my last post:

Understanding the Yield Spread


Why you should care:   As I mentioned in my last post on this topic, a narrowing of the yield spread is correlated with recession.  But not the 2-year.   I was talking about the spread between the 10-year and the 3-month.   As you will see below, this indicator is not indicating a problem is brewing.


Taking action:   We’re keeping you informed!


THE BLOG:   Here’s the 1-year history spread graph Rick was ranting about (click to enlarge):

10 2 spread

Looking at the red line, it’s easy to see why he might be concerned.   Around 1.7% a year ago, today the spread is less than 1% – only .94% as of June 1st.

Let’s look at the correct spread analysis:  the 10-year/3-month.   Here’s the 1-year chart:

10 3 mo spread

Sure it’s dipped from a year ago.   From a near 2.2% spread to 1.55% today.  The spread has been flat, right here, for about 4 months.    So rest easy.  No recessions signals here.

But what IS happening to the 10-year, 2-year spread?  Are 2-year Treasury rates spiking up, thereby slicing the spread to less than 1%?   Nope.   It the 10-year that’s falling.   What’s causing that?   Here’s the 1-year history chart:

10 year

From a bit above 2.2%, we can see it’s been hovering between 1.7% and 1.85% for, well, about 4 months.   About the same amount of time the 10-year/3-month spread has been about 1.55%

What’s really happening here is foreign buyers – unable to find yield overseas – are popping over the pond and purchasing Treasuries.   Take a look below:

bund v treasury

When the German 10-year ‘bund’ was yielding 1.8% in December of 2013, the US 10-year yielded 2.9%.   The graph above, created by the St. Louis FED only tracks the bund thru March of 2015 when it reached .23% … and the US 10-year T was 2.04%.

Today, the 10 year bund is trading at a yield of .13% … and this exceptionally low rate, for this exceptionally long time, has driven investor into our backyard.

Remember:  About $10-trillion of sovereign bonds now trade at negative yields.  By this comparison, the 10-year Treasury looks pretty good to foreign investors.   Even after considering FX concerns.

At a speech in Canton, Ohio in September of 1960, President Kennedy commented, “…a rising tide lifts all boats.”   This metaphor has been used by many for years.   And, of course, the opposite is true as well.   A falling tide lowers all boats.   It’s inevitable that the lowering tide of sovereign bond yields ultimately impact US Treasury yields.   They have.  And this will continue to be the case.

No, there’s no recession in sight – at least not by this metric.   And the 10-year Treasury is not going up any time soon.   We can all relax.  🙂

  • Terry Liebman

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