Since we published the June issue of What Counts, the one- to 10-year advance yield curve narrowed to 62 basis points, from 76 basis points. The yield spread between three-month and two-year advance rate widened to 58 basis points, from 54 basis points.

The relative “roll-down” benefit in the two-year sector continued to flatten, from 35 to 23 basis points. Now, virtually all points on the yield curve provide equal, albeit limited, amounts of incremental insurance against the potential of rising rates.

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

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 are now only 23 basis points of protection (versus 35 basis points one month ago) 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. An investor would have made the right decision, unless rates were to increase by more than 23 basis points during the one-year period.

The chart of current versus future implied swap yield curves suggests that markets are expecting little change in the shape of the yield curve beyond the two-year sector. Nevertheless, additional flattening is expected to take place in the short-end of the yield curve.

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