Since we published the April issue of What Counts, the spread between one- and 10-year advance yields narrowed slightly, from negative four basis points to positive three basis points. The inversion trend in the short-end of the yield curve is continuing, as the spread between three-month and two-year advance rate moved to negative 21 basis points, from negative 19 basis points.

The relative “roll-down” benefit in the two-year sector decreased to negative 25 basis points, from negative 31 basis points. This implies that the relative benefit of investing in a two-year, versus a one-year security, continues to be low.

• Purchase a one-year, fixed-income security (assumed to be pegged to Seattle Bank Advance Yield Curve), in this example, 5.42%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 5.29%.

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 indicates 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 short-term rates are expected to decline on the order or 25 basis points one year from now, with little change over the next six months. Longer-term rates are expected to show little change from current levels.

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