Wednesday, 22 of November of 2017

Economics. Explained.  

Treasury Notes — 10-Year Maturity

May 9, 2017

The yield on the 10-year note backed up dramatically following the election in November of last year as market participants feared that Trump’s tax cuts and the repatriation of funds currently held overseas could push the inflation rate  higher and force the Fed to tighten more quickly than it currently anticipates.   The rate rose from 1.7% right before the election to 2.6%.  But it now appears that any stimulative effect from the policy changes will take place later rather than sooner and the yield on the 10-year note has dropped back to 2.25%.

The question arises, what is an appropriate level for the 10-year note?   The answer to that question lies in something called the “yield curve” which is nothing more than the difference between long-term interest rate and short rates.  Today the 10-year note is 2.25%, the funds rate (an overnight rate) is 0.9%, so the difference between long rates and short rates, or the yield curve, is 1.35%.

The steepness of the yield curve varies depends upon whether the Fed is tightening or easing.  When the Fed tightens it raises short-term rates (i.e., the funds rate) much more rapidly than long-term interest rates rise, the yield curve “flattens” and can even invert.  When it inverts it means that short rates are higher than long rates, and the spread is negative.  Frequently an inverted yield curve can be a sign that the Fed has raised rates high enough that a recession might not be too far down the road.  On the chart below the Fed tightening periods are the periods shown in white.  You can easily see how the curve flattens, and even inverts when the Fed is in tightening mode.  That is not the case today nor will it be the case for several more years.

When the Fed eases they lower short rates (the funds rate) much more quickly than long-term interest rates decline and the yield curve “steepens”.  Periods when the Fed is easing are shown in pink in the chart above.  Once again the steepening of the curve when the Fed is in aggressive easing mode can be seen easily.

When the yield curve got to 3.5% the Fed was aggressively pushing the funds rate lower.  That is not the case today, and has not been the case for 6 years.  With the curve at 1.35% currently it is probably about where it should be for now.

Between now and yearend both short- and long-term interest rates may move slightly higher as the Fed continues gradual move towards a higher funds rate.  We expect the yield on the 10-year note to rise as well. The yield on  the 10-year note will probably climb by an additional 40 basis points between now and yearend to 2.65%.

Interest Rates -- 10-year versus mortgages projected

Stephen Slifer


Charleston, SC

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