|
|
Seattle Bank Yield Curve Optimal Points Analysis
Since we published the July issue of What Counts, the one- to 10-year advance yield curve widened slightly, to 64 basis points, from 62 basis points. The yield spread between the three-month and two-year advance rates widened to 71 basis points, from 58 basis points.
The relative “roll-down” benefit in the two-year sector increased, from 23 to 37 basis points. With the exception of the slight advantages presented in the two-year sector, virtually all points on the yield curve provide equal, albeit limited, amounts of incremental insurance against the potential of rising rates.
Consider the following investment alternatives covering a one-year time horizon:
1. |
Purchase a one-year, fixed-income security (assumed to be pegged to Seattle Bank Advance Curve), in this example, at 4.36%. |
2. |
Purchase a two-year, fixed-income security and sell after one year, in this example, at 4.54%. |
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 the one-year portions of the yield curve more than offset the loss?
Under current market conditions, there are now 37 basis points of protection (versus 23 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 237 basis points during the one-year period.
The chart below, illustrating current versus implied forward rate curves, suggests that markets are expecting little change in the shape of the yield curve beyond the two-year sector. Nevertheless, inside of the two-year sector, the wider spread between the current rate and expected rates one year into the future suggest continued increases in short-term rates.
Printable Version
E-mail this article
 |
|
Newsletter content is for our readers' informational purposes only.
Please refer to our Terms of Use for details. |
|