EC Yield Curve: Are We Okay Now?

Wow! What a week it was. Last week, I mean. Interest rates on the long end of the yield curve got yanked up so much the banking system ended up with a wedgie. The yield on the 30-year T-bond soared 35 basis points, the biggest five-day spike since, well, since a long time ago.

The shift in long-term rates is just part of the story, though. The very shape of the yield curve has changed dramatically since the summer of 2018. The question now is whether that change is being reversed.

Notice the red dotted line in the chart below? That describes the Treasury market just ahead of Independence Day 2018. It’s a normal, upward-sloping curve where long rates were higher than shorter-term yields. A year later (depicted by the blue line), a sag developed in the middle reaches of the curve as recession fears took hold.

The worst days for the curve were yet to come, though. By the first week in September, the trough had deepened (see the green line) even more. To boot, the long bond’s yield sank 8 bps below that of the one-month bill. Things were looking pretty bleak, at least according to bond buyers.

(Click on image to enlarge)

zig-yield-curve-normal.png

But cheer seemed to return last week. Oh, we’re not back to full-blown normalcy yet, but the curve’s beer belly has tightened (regard the black line) and long bond yields are once again richer than short rates.

So, is the scare over? Are sunny days ahead? Well, like any weather report, the prospect of unclouded skies isn’t permanent. It will be sunny until it isn’t. For now, though, there’s real chance of higher market yields. That means lower bond prices.

How low? Well, using the iShares 20+ Year Treasury Bond ETF (Nasdaq: TLT) as a proxy for the long end of the curve, it looks like last week’s breakdown set the stage for a further 9% price dip from Friday’s close. TLT ended the week at $136.54, after a six percentage point loss. We’re now looking at a tentative objective at the $125 level for TLT. Technically, that is, barring any surprise announcements from the White House or the Fed.

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