Since we published the August issue of What Counts, the spread between one and 10-year advance yields decreased to negative 5 basis points, from 0 basis points. In a continued inversion shift in the short-end of the yield curve, the yield spread between three-month and two-year advance rates moved to negative 13 basis points, from negative three basis points.

The relative “roll-down” benefit in the two-year sector decreased to negative 33 basis points, from negative 21 basis points. This implies that the relative benefit of investing in a one-year versus a two-year security continues to deteriorate.

• Purchase a one-year, fixed-income security (assumed to be pegged to the Seattle Bank Yield Curve), in this example, 5.47%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 5.30%.

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 forward yield curve would imply that an investor would be relatively better off by investing in a one-year security. Conversely, a borrower would be relatively better off by 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 a short-term rate decrease on the order of 25 basis points in one year’s time.

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