1/ Short Rates
2/ Yield Curve
3/ Long Rates
4/ Interest Rate Differentials
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1/ Short Rates
Interest rates have come a long way and in a relatively short period of time. Currently and for much of this year, the federal funds rate exceeded the 2-year treasury yield. The market will interpret this as the Federal Reserve is done hiking and will soon cut or decrease rates.
To couple this signal, the above chart highlights the 12-month rate of change of the 2yr treasury yield. Following an interest rate hiking cycle, a negative rate of change has historically preceded a further decline in rates.
2/ Yield Curve
The yield curve is still inverted. The 2-year treasury yield is higher than the 10-year treasury yield. However, we’ve seen significant steepening of the curve by way of long yields rising faster than short yields. A trader can take advantage of this scenario by going long short-term bonds and selling long-term bonds. What does a steepening yield curve mean for your portfolio?
3/ Long Rates
Interest rates are coming out of a near 40-year downtrend. To highlight the significance of the 2022-2023 move in rates, the below chart highlights a linear regression channelof the 30yr treasury bond yield. The 30-year yield broke out of the regression channel in September 2022 and hasn’t looked back since. A punishing 3-year period for bond investors.
4/ Interest Rate Differentials
There is a very high correlation between interest rate differentials and foreign exchange. For example, if we take the US 10-year treasury yield and subtract it by the Japan 10-year yield, the spread is closely correlated to the USDJPY currency pair.
The strong rise in the US Dollar relative to other global currencies can be primarily attributed to interest rate differentials and the US central bank’s hawkish policy stance. For example, if participants thought the US central bank would be more aggressive in their rate hiking relative to Europe, this translated into a strong Dollar over the Euro. Interest rates truly are the lifeblood of the financial markets!
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Originally posted 13th October 2023
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