Since we published the May issue of What Counts, the spread between one- and 10-year advance yields has significantly widened from three basis points, to 45 basis points. The inversion trend in the short-end of the yield curve has disappeared, as the spread between three-month and two-year advance rate moved to positive 15 basis points, from negative 21 basis points.

The relative “roll-down” benefit in the two-year sector increased significantly to positive 15 basis points, from negative 25 basis points. This implies that the relative benefit of investing in a two-year, versus a one-year security has increased.

• Purchase a one-year, fixed-income security (assumed to be pegged to Seattle Bank Advance Yield Curve), in this example, 5.59%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 5.66%.

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, slight 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 be only slightly better off by investing in a two-year security. Conversely, a borrower would be relatively better off by borrowing in the one-year sector.

The attached chart of current versus future implied swap yield curves suggests that short-term are expected to increase by on the order or 5 basis points over the next six-to-12 months. Longer-term rates are expected to increase by on the order of 10 basis points one year from now.

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