Monday, December 31, 2018

Yield Curve Watch

It looks like the market expectation is that this is the cyclical high point for the Fed Funds Rate.  It will be interesting to see if the FOMC insists on any more hikes.

In the meantime, the yield curve has become quite inverted.  Here is a chart of Eurodollar futures, which I like because it has a longer duration than Fed Funds futures.  The higher line is the yield curve on November 8, at the high point.  Even then, it was slightly inverted.  But, since then, even though near-term Fed Funds expectations have fallen, the yield curve in the 2-3 year range has fallen more.

Here, you can see how, at these low rates, there is a natural upward slope to the yield curve because the zero lower bound creates asymmetry in the expected yields on longer durations.  If you are using 10 year treasuries or some other longer term yield to estimate the yield curve, then you are getting a false signal.

I would say that, at this point, barring an unlikely additional bump in long term interest rates, the question is only how hard the landing will be, and that depends on how quickly the Fed reverses course.  It would be prudent if at the January meeting they pulled back 25 or 50 basis points, but that doesn't appear to even be in the set of potential options.  That would be the only chance at getting the "normalization" to 5%+ that I hear people talking about in long term interest rates.

It seems like the prudent position to take here is to maintain defensive positions until interest rates head back toward zero, and be ready to transition to equity at some point after the Fed starts to chase the natural rate down.  There could be a lot of noise between now and then, but it seems likely that in a year or so, equities will be available at prices near or below today's level and Treasury yields will be lower. (These are poorly informed opinions.  Do not use this blog for investment advice, etc. etc.)


  1. I hope you are wrong but you may be right.

    Thanks for a year of provocative insights.

    1. Thanks Ben. Thanks for all the great feedback and conversation.

      Here's to a happy 2019, regardless of yields and prices.