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HomeA Bear Flattener
Posted by Larry Doyle on June 8th, 2009 2:25 PM |
For those actively involved in financial markets, the term “bear flattener” is common knowledge. For those not actively involved in the markets, let’s quickly address this concept, what drives it, and what it may mean for the economy.
Let’s break the “bear flattener” into its component parts.
Bear: short for bearish, this term implies declining valuations or prices for whatever security or market sector is being analyzed.
Flattener: analysis of the U.S Treasury yield curve (or the yield curve for any market sector) is typically referenced in terms of whether the curve is flattening or steepening. Reflect back on Algebra II and the concept of slope. Yield curve analysis is all about the slope of the curve.
A flattening of the slope of the curve implies that rates for short maturities are rising faster than rates on longer maturies. In a rising rate environment, bond prices are declining thus the flattening is a bear flattener. If rates were falling but short maturity rates were not falling as much as long maturities, then the flattening would be considered a “bull” flattener.
What does a bear flattener portend for the economy? Typically a bear flattener is an indication of an economic contraction. Why? The rise in rates is usually a function of an increase in rates by the Federal Reserve. Why would the Fed raise rates? To slow the economy, the pace of inflation/expected inflation, or a combination of the two.
Let’s quickly review today’s price action across the U.S. Treasury yield curve. For purposes of measuring the slope of the curve, market analysts typically look at the relative performance and changes in rates on the 2yr Treasury note and the 10yr Treasury note. In today’s price action:
2yr Treasury note has increased by 8 basis points to 1.38%
10yr Treasury note has increased by 3 basis points to 3.86
The 2/10 slope thus equates to 2.48% or 248 basis points. The curve has flattened by 5 basis points today.
Be mindful that although the curve has flattened today as well as the last week (the slope peaked at approximately 275 basis points), the curve started the year at a rather flat level of 1.52% (152 basis points).
A steepening curve is beneficial to financial companies and typically, though not always, indicates an improving economy. A steepening curve can also be a harbinger of inflation as the increase in long term rates is a sign that inflation is likely to increase.
A flattening curve is typically an indication of a slowing economy and is definitely not beneficial to financial companies as funding costs increase.
As evidenced in my initial post this morning, Bernanke Conundrum, the market will often adjust interest rates and bond prices well before the Fed actually changes interest rates and Fed policy.
Thus, despite what market analysts or government officials may say, the slope of the yield curve speaks volumes.
Why don’t you engage your better half this evening with, “Did you see that bear flattener today?” Who knows, it may take your relationship into an entirely new realm as you navigate the economic landscape!!
LD
Front End Springs a Leak
Posted by Larry Doyle on June 5th, 2009 4:57 PM |
In a manner of speaking, the management of our economy has been nothing short of a major overhaul of a tired old ship. When the tide went out, the base of our ship was exposed as being filled with holes.
Little did we know at the time, but through many of those holes a number of “pirates” were running off with a whole lot of booty. In the process, many market participants riding along on the main deck were thrown overboard by the economic storm that hit our economy and markets over the last two years.
We do not have the luxury of bringing our ship into port for an overhaul. We have had to continue to sail this ship while trying to repair it. In that spirit, by necessity we have had to add significant ballast (liquidity) in our hull. In so doing, we need to recognize that the ballast can itself be inflammatory if the engine generates a spark.
In purely economic terms, this morning’s non-farm payroll number of -345k jobs was a hint of a spark. While various sectors of the market gyrated today, the front end of our ship, that is the front end of our yield curve, sprung a serious leak. How so? Interest rates on short term Treasury notes increased a DRAMATIC 35 basis points. Why?
Traders are already pricing in an expectation that the Federal Reserve will be forced to increase the Fed Funds rate prior to any hint of inflation or even the expectation of inflation gains a foothold. Bloomberg sheds color on this likelihood, Traders Begin to Speculate Fed Will Need to Tighten:
Traders are beginning to price in expectations the Federal Reserve will raise interest rates this year as the recession shows signs of abating.
Federal-funds futures contracts on the Chicago Board of Trade show a 70 percent probability the central bank will lift its target rate for overnight bank borrowing to at least 0.5 percent by November after a report today showed the U.S. economy shed the fewest jobs in May in eight months. Rate-increase odds were 27 percent yesterday.
The Fed cut the target rate to the record low range of zero to 0.25 percent in December as the economy lapsed into the worst recession in decades. President Barack Obama and Fed Chairman Ben S. Bernanke have committed $12.8 trillion to thaw frozen credit markets and ramped up government spending to revive growth. The Fed last raised borrowing costs in June 2006, when policy makers pushed the rate to 5.25 percent.
Fed governors and Fed chair Bernanke now face a serious quandary. Economic data will remain decidedly weak. Unemployment will continue to increase. Consumers are going to remain strapped. Corporations will face challenges. Municipalities will encounter an ongoing decline in tax revenues. Nobody is going to truly feel like the economy is improving to the point that the Fed should even think about increasing interest rates. Then why is the market starting to price that reality into the market? Let’s go back into the hull.
The bowels of our ship are flush with liquidity and given any sort of traction in the economy, the velocity and growth in the money supply will drive inflation.
What is Big Ben and team to do? The market is raising interest rates on him rather than his raising interest rates on the market. In the process, a very fragile economy will now be forced to deal with higher interest costs along with anemic growth.
What do I see on our economic horizon? In my opinion, today’s price action took us in the direction of the island known as Stagflation.
Please share your thoughts and comments.
LD
