Sunday, August 2, 2009

10 year US Treasury bond yield analysis

I was wondering on the possibility of the yield of the 10/year T-bonds (from now, the TNX) to continue up, if we consider that a sharp correction in the financial markets is very likely.

Then, I started looking at the correlation between the TNX and the S & P 500. Here are the results:

As we can see in the chart, there is no evidence of correlation between the indexes. Then, it is possible to expect new lows for the market, with a flat or rising TNX (like the January - March 2009 period). The red line represents the regression line, which estimates the relation between the two variables, the TNX and the S & P 500. The R square is 0.001, almost null. Number of observations: 2481. From January 1962 to July 2009.

What about the Fed Fund Rate?

Macroeconomic theory tells us that long term interest rates tend to move in the same direction with short term interest rates. Then, we would expect the yield on a long term asset like the 10 year T-bond to move up when short term rate like the federal funds rate moves up.
I read a paper entitled "How the Federal Reserve Fund rate affect the 10-year T-Bond yield" and conclude that the federal reserve funds directly influences the 10 year T-bond yield.

TNX vs. Fed Fund Rate:

In addition, from the fundamental side, I do not expect a new "flight to quality". The reasons:

1) The constant issue of new debt from the treasury. The government debt is loosing "quality".

2) The panic. We do not have a panic or high since October 2008, and it is not expected new volatility for the future as we can see in the dowtrending VIX.

3) The Federal Reserve does not have space to decrease the FED FUND rate given the current levels.

4) In the short term, I expect that the FED will continue with the minimum discount rate, because at the moment inflation is unlikely. But, in the near term, with the economy improving, the inflation threats will oblige the Fed to rise interest rates. This will push up the TNX, and, which is more dangerous, the conventional mortgage rate. See the chart:

Technical perspective:

TNX daily chart:

TNX monthly chart:

As I always say, this is my humble opinion. But this are the facts. It would be interesting to know your opinions.

Source of research:


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