Various market observers have remarked that the yield curve is flattening. That means that the spread, that is, the difference, between the yield of short-term Treasuries (US government bonds) is decreasing in relation to the yield of long-term Treasuries. The two-year bond, which is to be considered short-term, is currently at about 1.75% ($UST2Y 1.75) and should be compared with the five-year yield ($UST5Y), which is at 2.07%, and the ten-year yield ($UST10Y) at 2.43%.
The election of Donald Trump to the office of President of the United States in November 2016 was followed by a rise in Treasury yields immediately afterwards and practically all through 2017. Bond experts know that when the yield of a bond in the secondary market goes up, the price of the bond falls and vice versa. The conclusion to be drawn is that demand for Treasuries decreased. In other words, there were more sellers than buyers. This is particularly evident for the two-year bond whose yield in November before the election was 0.8% while the ten-year yield increased from 1.7%. So the two-year yield increased by almost a whole percent while the ten-year yield increased by only about 0.65%.
This tendency was accompanied by dollar weakness in the foreign exchange markets. Even though Saudi Arabia still insists on US dollars as payment for oil, Russia and China have been laying the groundwork for the petro-yuan while China is now insisting on international payments in yuan rather than US dollars. This will have as a result that central banks in emerging markets, especially in Asia, will start increasing their reserves in yuan and very probably will decrease the amount of US dollars held in reserve.
Another point to consider is that large amounts of US debt in the form of Treasuries are held by foreign countries, and that includes China. The PBoC therefore finds itself in a position characterized by a desire to strengthen the yuan and make it a leading international currency while at the same time a wish not to lose money if the US dollar weakens excessively very fast as that would mean that holdings in US Treasuries would be worth less. That means that the Chinese will not be happy about increased yields for US Treasuries along with a weak US dollar when they would like to sell US debt. A flattening yield curve is therefore unwelcome in certain circles.
What it means for investors is that money managers have been selling shortterm Treasuries. When long-term bonds have a lower yield than short-term ones, that is usually a signal that a recession in not far away. And the Fed plans on more interest rate hikes in 2018. So one should not buy one-hundred-year Argentinian bonds.
Disclaimer This Newsletter has been prepared by WWS Swiss Financial Consulting SA (the company). Even though every effort has been taken to ensure the accuracy of the content of the Newsletter, there is absolutely no guarantee that the information contained in it is correct, up-to-date, accurate or otherwise applicable. It is not intended as a solicitation, invitation or recommendation for the purchase or sale of any investment fund or product or security or financial instrument or to participate in any particular trading strategy or banking product in any jurisdiction. It is not to be distributed in any country or area where it is legally prohibited. No liability whatsoever is or will be assumed by the company for any damage, loss or negative result of any sort ensuing from following views expressed and contained in the Newsletter. Investors themselves assume the full risk for any decisions that they take (caveat emptor). The Newsletter may not be reproduced or published by anyone anywhere in any way or form without the express written permission of the company.
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