Since February, the spread between one- and 10-year advance yields has narrowed slightly, from 204 basis points to 197 basis points. The inverted spread between three-month and two-year advance rates has narrowed from negative five basis points, to positive 29 basis points.

The relative “roll-down” benefit in the two-year sector increased from 15 basis points to 37 basis points. This implies that benefit is starting to accrue in terms 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, 2.83%.
• Purchase a two-year, fixed-income security and sell after one year, in this example, 3.01%.

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, a slight degree of 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 implied forward yield curve indicates that an investor would slightly better off investing in a two-year security. Conversely, a borrower would be relatively slightly worse 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 on the order of 25 basis points over the next 12 months. Longer-term rates are expected to increase on the order of 25 to 30 basis points one year from now. These variables would suggest future steepening of the yield curve.

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