The Steepening Yield Curve for U.S. Treasuries

2016

Week of February 22, 2016Austin Polk

Finance 401-Money and Capital Markets | Southeast Louisiana

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Austin Polk

Danielle Lewis, Ph.D.

Finance 401-01

14 March 2016

The Steepening Yield Curve for U.S. Treasuries

During the week of February 22, 2016, the overall yield curve for U.S.

Treasury securities steepened. The steepening of the yield curve indicates

that investors predict an increase in future rates. With investors expecting

rates to rise in the future, they are selling their long-term securities in

exchange for short-term securities. This increase in the demand for short-

term securities raises the price which forces the interest rates to lower.

Investors push the price down, by selling their long-term securities causing

the rates to increase on the long-term end of the yield curve; this is

consistent with Figure 1.1.Figure 1.1

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There are various factors that contribute to the daily effects of the

yield curve.  The curve flattened from Monday to Tuesday, see Figure 1.2,

with an average percent change in yield of -1.323%.   One of the factors to

which this flattening trend can be attributed to, is the weakening of the

British pound against the U.S.

dollar.  This weakening of the

currency is due to what is being

called “Brexit”; the campaign for

Britain to exit the European

Union.  “Brexit” is causing

investors to buy more treasury securities which makes

prices increase while yields drop. According to Christopher Maloney and

Elizabeth Stanton, reporters for Bloomberg, the British pound has fallen a

total of 1.74% ("U.S. Rates/Credit Daybook: Chicago Fed Index; $67b 3M/6M

Bills").  Another factor causing the yield curve to flatten, is the global oil

crisis.  On Monday, there was a rally for oil and global equities, which

reduced the demand for treasury securities, causing the prices of treasuries

to fall and the rates to increase. On Tuesday, however, reports were issued

stating that Saudi Arabia had refused to cut their oil production. This news

caused a slide in oil and stock prices, which in turn increased the demand for

treasury securities ("Treasuries Climb as Sliding Stocks, Oil Boost Demand

for Havens").    The events on Tuesday both caused the yield curve to flatten

because investors’ expectations relating to global concerns were sparking

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Figure 1.2

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uncertainty, driving them to participate in less risky investments, such as

U.S. Treasuries.

The smallest change of the week occurred from Tuesday to Wednesday

which had an average percent

change in yields of -0.0485%.

The flattening of the yield curve

is illustrated in Figure 1.3,

representing the small percent

change.  The yields for Tuesday

and Wednesday are seen as moving almost in tandem with

each other over the entire yield curve.  A possible cause for the slight

flattening  of the yield curve is that on Wednesday there was an auction

scheduled for $13 billion worth of two year Floating Rate Notes (FRNs), and

$34 billion worth of five year securities ("U.S. Rates/Credit Daybook: Chicago

Fed Index; $67b 3M/6M Bills").  The U.S. sold the five year securities at the

“lowest yield at an auction of the securities since 2013” ("Treasuries Decline

as Oil Rally Reduces Demand for Haven Assets").   This would cause the

short-term rates to decrease slightly; nevertheless, the rates moved right

back in tandem with Tuesday’s yields quickly after R2.

From Wednesday to Thursday, there was a more substantial flattening

of the yield curve (Figure 1.4) at an average percent change of -2.5937%. A

report emerged Thursday warning of a Global recession. This warning came

from one of the primary dealers of the U.S. treasury’s securities, Citigroup

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Figure 1.3

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Inc. The report also mentions that

it is “risk off in the financial

market” ("U.S. Notes Gain for Fifth

Week as Citigroup Warns of

Recession"). This means that

investors are moving from

equities to treasury securities. The Brexit issue also caused investors to run

to treasuries, or haven assets, on Thursday due to the fear that Britain

leaving the European Union would cause massive global turmoil ("Treasuries

Gain on Speculation Foreign Turmoil Is Driving Demand"). The Brexit

movement and the Citigroup Inc. warning, both caused investors to flee the

equities market for the treasuries market. This run to the treasuries caused

prices to rise at the influx of investors which in turn made the yields fall.

David Ader, Head of rates strategy with CRT Capital Group LLC in Stamford,

Connecticut said, “We’re not trading the norms of what we typically look at

in here. We’re not trading data, we’re not trading inflation--we’re trading

fear. We are being held hostage to activities overseas” ("Treasuries Gain on

Speculation Foreign Turmoil Is Driving Demand"). What David Ader means is

that investors are trading because they are scared of how the global

concerns facing Europe’s political future will affect the U.S. economies as

well as the markets.

On Friday, the market turned around. According to Alexandra Scaggs, a

reporter for Bloomberg, the gauges of growth for the U.S., such as price

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growth, economic growth,

consumer spending, and

consumer sentiment, were all

higher than the economists had

expected ("Treasuries Plunge as

Economic Growth, Inflation

Exceed Forecasts"). This means that the economic expectations from

investors were improving as well as causing the yield curve to steepen at an

average percent change of 5.2099%. This was a substantial steepening of

the treasuries yield curve (Figure 1.5). The report claims that some of the

recession fears were over-exaggerated, causing the fear aspect of the

market to lessen ("Treasuries Plunge as Economic Growth, Inflation Exceed

Forecasts"). The increase in economic expectations caused people to sell off

their treasuries and to start buying more risky assets. This caused the price

to fall for the first time all week, which in turn caused the rates to surge. The

magnitude of this steepening in the yield curve is what caused the overall

yield curve for the week to have steepened.

After analyzing the yield curve changes over the course of the week it

is clear to see that the overall yield curve has steepened. The investor’s

expectation of rising interest rates is consistent with the forecast made

regarding future interest rates. Based off of the interest rates from this week,

as well as the steepening of the yield curve, interest rates should increase

over the next ten years. This can be seen in Figure 1.6. Between Monday

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and Friday, there are some small

fluctuations in the forecast, and

these fluctuations can be

attributed to the treasury

auctions that were held over the

course of the week. The massive

influx of securities being purchased at lower yields during the week caused

the interest rates to fluctuate which in turn caused the forecast to fluctuate.

It should be noted that the fluctuations on the forecast curve are consistent

with the securities being auctioned off during the week.

Overall, during the week of February 22, 2016 the yield curve

steepened. This steepening effect was caused by the positive expectations

regarding economic growth. The positive expectations caused investors to

move out of long-term securities into short-term securities because they

expect interest rates to rise in the future, and they do not want to be stuck in

a low yielding long-term security as interest rates are rising. The forecast

made is consistent with this expectation. Interest rates should rise in the

next ten years. It is very clear to see that the various economic conditions

that took place over the week greatly affected interest rates causing the

yield curve to both steepen and flatten. The “Brexit” movement caused

flattening of the yield curve based off of investor uncertainty. The global oil

crisis caused the yield curve to flatten due to Saudi Arabia not cutting oil

production. Even with both of these factors trying to flatten the curve, the

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expectations of investors is what caused the largest movement. The

investor’s expectations were so great that it turned a substantially flattening

yield curve into a steepening yield curve.

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Works CitedGoodman, Wes. "U.S. Notes Gain for Fifth Week as Citigroup Warns of

Recession." Bloomberg. N.p., 26 Feb. 2016. Web. 14 Mar. 2016.Maloney, Chistopher, and Elizabeth Stanton. "U.S. Rates/Credit Daybook: Chicago

Fed Index; $67b 3M/6M Bills." Bloomberg. N.p., 22 Feb. 2016. Web. 14 Mar. 2016.

Scaggs, Alexandra. "Treasuries Climb as Sliding Stocks, Oil Boost Demand for Havens." Bloomberg. N.p., 23 Feb. 2016. Web. 14 Mar. 2016.

Scaggs, Alexandra. "Treasuries Decline as Oil Rally Reduces Demand for Haven Assets." Bloomberg. N.p., 24 Feb. 2016. Web. 14 Mar. 2016.

Scaggs, Alexandra. "Treasuries Plunge as Economic Growth, Inflation Exceed Forecasts." Bloomberg. N.p., 26 Feb. 2016. Web. 14 Mar. 2016.

Wong, Andrea, and Alexandra Scaggs. "Treasuries Gain on Speculation Foreign Turmoil Is Driving Demand." Bloomberg. N.p., 25 Feb. 2016. Web. 14 Mar. 2016.

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