Tuesday, May 4, 2010

The yield curve is king at providing advice

Sometimes you can over think about the direction of interest rates.

Inflation and inflation expectations have bean surprisingly steady over the longer-term for most G10 countries. The Fed has trained everyone that long-term expected inflation will be 2.5%.

Debt issuance matters, but maybe not as much as we think given the open global capital markets.

Real rates are also surprisingly steady and cannot explain much of the variation in rates.

However, the employment and overall credit picture does matter when tied with the behavior of the yield curve.

What may be most important indicator to watch is the shape of the yield curve. The market moves to extremes and then has a systematic adjustment. Follow the yield curve. If it is inverted, there will be Fed action to get it back to positive and there will be a rally. If it is very steep, the opposite action will be called for and there will be a bear flattener. This behavior has been followed for decades. There is mean reversion in the yield curve that you cannot fight. Perhaps the advice is simple, when the curve moves to extreme the Fed will change. Still it works.

No comments: