Since the March issue of What Counts, the one- to 10-year advance yield curve narrowed to 112 basis points, from 135 basis points. The yield spread between three-month and two-year also narrowed to 95 basis points, from 97 basis points.

The relative “roll-down” benefit in the two-year sector reversed course from last month and decreased from 79 to 61 basis points. Nonetheless, the two-year sector 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:

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 would like to 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 61 basis points of protection (versus 79 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. An investor would have made the right decision, unless rates were to increase by more than 61 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 would still represent 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 eight- to 10-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.

IMPORTANT DISCLAIMER, PLEASE READ: The Federal Home Loan Bank of Seattle ("Seattle Bank") publishes What Counts for educational and promotional purposes only. The data and analysis presented are based upon information obtained from sources that we consider reliable. The opinions expressed represent the current opinions of our staff and are subject to change without notice. We make no warranties, express or implied, regarding the accuracy or completeness of any information, analysis, or opinions presented. No part of this newsletter may be reproduced in any manner without the written permission of the Seattle Bank. The Seattle Bank, its employees, agents, and contractors are not registered investment advisors, financial advisors, or broker dealers, and they are not acting in a fiduciary capacity. The information contained in this newsletter does not constitute a recommendation, offer to sell, or solicitation of an offer to purchase any particular investments or products, including without limitation securities of any companies discussed, and it should not be construed as such. It is the reader’s responsibility to evaluate the suitability, risks, and merits of any investment, funding strategy, or business proposal presented in this newsletter. Newsletter content is for our readers' informational purposes only. Please refer to our Terms of Use for details.