Since November, the spread between one- and 10-year advance yields has narrowed from 79 basis points to 67 basis points. The inverted spread between three-month and two-year advance rates has expanded from negative 24 basis points, to negative 47 basis points.

The relative “roll-down” benefit in the two-year sector narrowed from positive 19 basis points, to negative 35 basis points. This implies that there is still no relative benefit of investing in a two-year, versus a one-year security.

Consider the following investment alternatives covering a one-year time horizon:

• Purchase a one-year, fixed-income security (assumed to be pegged to Seattle Bank advance yield curve), in this example, 4.42%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 4.24%.

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, by historical standards, minimal protection from rising rates over a one-year period for an investor that 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 not be better off by investing in a two-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 by on the order of 25 to 50 basis points over the next 12 months. Longer-term rates are expected to increase on the order of 10 basis points one year from now. These variables would suggest future steepening of the yield curve.

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