Thursday, June 17, 2021

In The Belly Of The Beast

 Bond yields spiked up after yesterday’s Fed comments. While most everyone looks at long bonds with maturities 10+ years, the real “action” is taking place in the yield curve’s “belly”, the 5 to 7 year maturities. 

Given the current shape of the yield curve, right now that’s the most sensitive and important spot to pay attention (chart below)  Let’s examine today’s yield curve (blue line).  

First off, it’s very steep, meaning bond investors expect interest rates to rise, so they demand more return for the extra duration risk. Rates overall are significantly lower than in 2019, particularly in the “belly” 5-7 years (the very short term is 100% Fed, it doesn’t matter what bond traders do). 

Notice how the biggest difference in today’s yields vs 2019 is in precisely that 5 year maturity, almost 100 basis points (1%).  Should rates continue to rise, that’s where the biggest potential yield upside resides, and, thus, the biggest market risk.

What does the 5-year bond yield chart look like? In a word, very interesting - see below. If you are a chartist, the current pattern is a flag and pole, ie a continuation pattern that “reads” at least 80 bp (0.80%) higher. That dovetails very well with the yield curve comment above.

Also, on the same chart notice how previous flagpole patterns were good predictors of subsequent moves.

As always, take such comments as mere observation and thought. I’m no prophet…