Since we published the February issue of What Counts, the one- to 10-year advance yield curve remains at 135 basis points. The yield spread between three-month and two-year reversed course and widened from 81 basis points, to 97 basis points.

Notwithstanding the significant flattening of the yield curve in recent months, the relative “roll-down” benefit in the two-year sector has actually increased over the past month, and continues to provide a slightly higher amount of incremental insurance against the potential of rising rates compared with longer points on the yield curve.

Consider the following investment alternatives covering a one-year time horizon:

	Purchase a one-year, fixed-income security (assumed to be pegged to the Seattle Bank Yield Curve), at 3.57% in this example.
	Purchase a two-year, fixed-income security, at 3.96% in this example, and sell after one year.

In deciding whether to purchase the one-year security, as opposed to purchasing the two-year security and selling it at the end of one-year, an investor should know the answer to a key question: In the event of rising interest rates, even though a modest principal loss would be sustained, would the extra yield earned, relative to one-year portions of the yield curve, more than offset the loss?

Under current market conditions, there are 79 basis points of protection (versus 69 basis points one month ago) from rising rates over a one-year period for an investor who opts to purchase a two-year security and sell it at the end of the first year. The investor would have made the right decision, unless rates were to increase by more than 79 basis points during the one-year period.

Since the two-year sector supports the highest point to break-even in the event of a rate rise, this portion of the yield curve still represents the optimal place to invest at the present time. Conversely, this point would represent the least optimal place on the yield curve to borrow. As such, the 8- to10-year, or three- to six-month sectors [where there is less curve roll-down (or incremental yield pick-up)] remain the most optimal areas for borrowing.

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