interest rate forecasting paper
TRANSCRIPT
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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