Since we published the June issue of What Counts, the spread between one- and 10-year advance yields decreased to five basis points, from eight basis points. The yield spread between three-month and two-year advance rate increased slightly to 19 basis points, from 18 basis points.

The relative “roll-down” benefit in the two-year sector decreased to negative nine basis points, from positive one basis point. From a historical perspective, virtually all points on the yield curve continue to provide equal, albeit insignificant, amounts of incremental insurance against the potential of rising rates.

• Purchase a one-year, fixed-income security (assumed to be pegged to the Seattle Bank Yield Curve), in this example, 5.78%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 5.73%.

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 is virtually no protection 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. At current levels, the current implied forward yield curve would imply that an investor would be relatively better off investing in a one-year security. Conversely, a borrower would be relatively better off borrowing in the two-year sector.

The attached chart of current-versus-future implied swap yield curves suggests that longer-term rates are expected to show little change from current levels. Conversely, the market appears to be discounting short-term rate increases of between 25 and 50 basis points over the next six months. Thereafter, the market appears to be discounting stable-to-slightly-declining short-term rates.

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