Seattle Bank Yield Curve � Optimal Points Analysis

Since we published our September issue, the one-to-10-year advance yield curve has flattened from 368 basis points to 352 basis points, and the optimal point to invest has shifted slightly in the direction of the three-year maturity. The intermediate portion of the yield curve still accords the most incremental yield and provides some degree of protection to investors in the event of rising interest rates.

At this point, you’ll want to consider the following investment alternatives covering a one-year time horizon:

1.
 Purchase a one-year fixed-income security (assumed to be pegged to the Seattle Bank’s Yield Curve), in this example, 1.37%.
2.
 Purchase a three-year fixed-income security and sell after one year, in this example, 2.65%

In deciding whether to purchase the one-year security, as opposed to purchasing the three-year security and selling it at the end of one-year, you should know the answer to this key question: in the event of rising interest rates, would the extra yield earned relative to one-year portions of the yield curve, more than offset a modest loss of principal?

Under current market conditions, there are 131 basis points of protection from rising rates over a one-year period for an investor who opts to purchase a three-year security and sell it at the end of the first year. (This is down from 143 basis points at the time of the September issue.) Unless rates were to increase by more than 131 basis points during the one-year period, this would be the right decision.

Since the two-to-three-year sector supports the highest point to break-even in the event of a rate rise, this portion of the yield curve represents the optimal place to invest at the present time. Conversely, this point would represent the least optimal place on the yield curve to borrow. As such, the eight-to-10 year, or three-to-six month sectors [where there is less curve roll-down (or incremental yield pick-up)] remain the most optimal areas for borrowing.