|
|
Seattle Bank Yield Curve Optimal Points Analysis
Since we published the September issue of What Counts, the
spread between one-year and 10-year advance yields decreased from 64 basis
points to 42 basis points. The yield spread between three-month and two-year
advance rate widened to 54 basis points, from 39 basis points.
The relative “roll-down” benefit in the two-year sector remained
at 19 basis points. 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:
1. |
Purchase a one-year, fixed-income security
(assumed to be pegged to Seattle Bank Yield Curve), in this example,
4.61%. |
2. |
Purchase a two-year, fixed-income security and sell
after one year, in this example, 4.70%. |
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 19 basis points of protection
(unchanged from 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 19 basis points during the
one-year period.
The chart below, depicting 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 short-term
rate increases on the order of 50 basis points over the next three months,
along with another 25 basis points by the end of the sixth month. Thereafter,
the market appears to be discounting stable short-term rates.
Printable Version
E-mail this article
 |
|
Newsletter content is for our readers' informational purposes only.
Please refer to our Terms of Use for details. |
|