Archive for the ‘Yield Curve’ Category

The Fed Goes Long

Friday, April 18th, 2014

Few investors today would consider investing in long-term Treasury bonds.

The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.

A 10-year Treasury is still yielding less than 3% interest.  If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.yield-curve-investwithalex

If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield.  What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?

The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression.  During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation.  But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.

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