Trading Post

July 29, 2014 11:57 am

Flattening curve may be investor message

Narrowing yield spreads could be eyed warily by the Fed

The US Federal Reserve is expected on Wednesday to announce the tapering of its bond-buying programme by another $10bn, to $25bn a month.

Its main interest rate will stay at between 0 to 0.25 per cent. It’s not moved for more than five years.

But a rise is coming, even if markets believe any tightening will be glacial.

The September 2015 Fed Funds Futures contract points to a 0.54 rate, the December 2015 suggests 0.78 per cent.

This investors know. Stocks are saying they can cope with it (can they handle another Fed comment on bubbly conditions? Probably.)

But clearly the danger for investors, which was one of the volatility risks we highlighted in the previous Post, is a Fed that has to tighten faster than expected.

The US 2-year bond yield rose to 0.55 per cent this week, the highest since mid-2011. A $29bn auction on Monday of new equivalent maturity notes saw soft demand. A message from investors?

The yield spread between 2-year and 30-year US notes contracted to 270 basis points, the smallest in more than a year. The 5-year to 30-year is at its most narrow since 2009.

A flattening yield curve may be eyed warily by the Fed and banking sector investors alike.

jamie.chisholm@ft.com

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