Past may be no prologue for Treasury investors when Federal Reserve policy makers begin to withdraw their unprecedented monetary stimulus without raising interest rates.
For the first time since at least 1980, a change in monetary policy may mean the difference between short- and long-term Treasury yields will widen rather than narrow.
The threat of the Fed selling the $2.29 trillion in securities on its balance sheet, combined with record Treasury auctions, will keep longer-term yields higher, according to Deutsche Bank AG, one of 18 primary dealers that trade directly with the central bank.
A so-called steeper yield curve would boost borrowing costs for companies and home buyers while attracting money managers deterred by record-low rates. President Barack Obama needs to lure investors more than ever as Treasury extends average debt maturities and finances a budget deficit that the government predicts will expand to an unprecedented $1.6 trillion in the fiscal year ending September 30. “The policy for the Fed to keep rates low for an extended period of time will keep front-end rates lower for longer,” said James Caron, head of US interest-rate strategy in New York at Morgan Stanley, another primary dealer.
“The weight of supply and the risk premiums for inflation may rise as the Fed keeps rates low, that will increase the term premium on the curve and the 10-year note yield will rise to reflect that.” The yield curve, or the gap between two and 10-year Treasury note rates, widened to a record 2.94 percentage points on February 18, before narrowing to 2.80 percentage points on February 26. Yields on two-year notes fell 10 basis points to 0.81 percent last week.
Those on 10-year securities dropped 16 basis points to 3.61 percent even after the government sold a record $126 billion in notes and bonds.
The 10-year note yield advanced 2 basis points to 3.63 percent as of 8:40 a.m. in London, and the curve spread was little changed.
