Keep an Eye on the Yield Spreads

April 18, 2018 12:30PM CDT

30-yr Treasuries are just about where we left them two weeks ago, trapped in a upward channel.  This makes for good technical trading while it lasts, however it’s my contention that the path of least resistance in the weeks and months to come will be down. 

For now, the long end of the treasury spectrum is staying stubbornly strong since a tepid employment report was released on April 6.  Keep an eye on the yield curve, which has flattened considerably as of late, with the yield spread between the 2 and 10-yr, and the 5 and 30-yr narrowing to levels not seen since 2007.  A flattening curve can be a portent of sluggish growth in a rising rate environment.  We know the Fed has shifted to a tightening monetary policy, with two more interest rate hikes slated for this year, and further hikes in the next two years.   This policy is being implemented in the midst of a massive tax cut that has given the economy a shot in the arm but will come with a big bill in the form of a ballooning federal deficit.  It is this deficit that is worrying economists and putting into question how long the shampoo effect of the tax cuts will last.  The international monetary fund recently said that the impact of the tax cuts would be short lived. 

Looking forward, it will be informative to watch how the Fed approaches the flattening of the yield curve.  It may cause a dilemma if long-term yields don’t start to rise.  On the one hand they want to get ahead of any potential inflationary pressure, and with the unemployment rate the lowest since 2000, wage growth is starting to percolate.  On the other hand, a flattening or inverted yield curve has historically been a precursor to recession.   As noted in the beginning of the article, it is my conjecture that the yields on the long end of the curve will resume their trend which is up, and the 30-yr bond future will break out of the channel to the downside.  Remember that yields move inversely to price.  This offers opportunity in the months to come, either trading the spreads, or outright futures.

30-Year T-Bond Jun '18 Daily Chart

T-Bond Jun '18 Daily Chart

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