Yields and the Curve – A Quick Look

Jun 13, 2008: 10:56 AM CST

Short-Term treasury yields have been rising lately, driving bond prices down and potentially confusing investors who escaped the stock market in the recent past to escape the downward volatility.  It is time to switch?

Many investors and financial adviser instructed their clients to buy bonds to ride out the upcoming market volatility, some doing so as early as August of last year.  That was a factor in driving bond prices up and yields down (along with the Federal Reserve slashing interest rates), and indeed the US Stock Market experienced some downside volatility into 2008.  Many advisers purchased short-term notes (2 years or so), expecting this would be market correction lasting about that duration, and then rotate clients back into the stock market.

But with that portion of the bond world being potentially ‘overcrowded,’ are these same advisers now at risk and shifting out of the short-end of the bond market, helping push yields higher?  Remember, the Federal Reserve has not yet hiked interest rates, but are signaling a “wait and see” environment.  While there are certainly many more reasons why yields may be headed higher, let’s take a look at the charts:

Two-Year Treasury Note Yields have risen from a low beneath 1.5% in March now to a 2008 high at 3.00%, with the yield doubling in four months.  Bond prices (not shown) have seen a corresponding fall as well.

Investors who locked in rates last year are still collecting their interest payments, but if you just now entered say a bond ETF, chances are you’re down a little bit on the position in terms of price movement while the US Stock Market recovered (at least since March).

One thing to note about yields (and bond prices) is that they tend to trend much stronger and solidly than the Equity Markets.  According to the chart shown below, which dates back to 2000, you can see that yields have much smoother action, and when a change in direction is signaled (especially on the monthly chart), that direction tends to persist.

There was really only one aberation in the smooth trend – that being in late 2001 around the time of the September 11th attacks, when investors perhaps overshot the ‘flight to quality.’  Nevertheless, at all other times in the chart, there really have been few retracements – only pure trend.

One thing to note is that yields often don’t ‘change direction on a dime,’ but instead flatten out and form rounded patterns before changing direction.  The most recent change (with the doji) represents a ‘change on a dime’ pattern, but nevertheless, the monthly trend appears to be changing.

Yields found a bottom at the lowest levels of the decade, which also occurred just below 1.50% and now appear to be headed higher (bond prices appear to be headed lower).

Remember that if you purchased an actual 2-Year Treasury Note, you should not be concerned by daily or weekly price losses that your Note (bond) is showing.  At redemption, you will receive the full value plus interest.  If you’re in a bond ETF however, the situation is different, and you’re at greater risk of price fluctuations.

We’ll continue to watch these developments and what they might mean for the overall Stock Market.

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