While a December rate increase is still seen as a done-deal, Fed Chairman Jerome Powell’s comments that interest rates are “just below” the so-called neutral range changed the 2019 outlook. The spread between December 2018 and December 2019 eurodollar futures -- a measure of how much tightening traders expect next year -- is currently just 23 basis points, the equivalent of less than one Fed hike.
The 3-year to 5-year spread is not the only one nearing inversion. The gap between 2-year and 5-year Treasury yields fell to an 11-year low of 1.9 basis points on Friday as 5-year Treasuries added to their weekly gain.
To be sure, the richness of the 5-year sector on the curve has enticed sellers, who Thursday carried out a series of futures block trades betting the sector will cheapen relative to the 10- and 30-year points.
We tend to pay attention to the 10-year – 2-year spread as one of the primary arbiters of tightness in the monetary system. The basic rationale is banks make money by borrowing short-term and lending long-term. When the spread is inverted it reflects a time when that trade no longer works so banks restrict lending which tightens credit conditions in addition to the tightening which is already underway from the Fed. I can see the rationale for using a longer-dated spread like the 3-month to 30-year as Jeffrey Saut recommends, but why would anyone look at the 3 to 5-year spread?Click HERE to subscribe to Fuller Treacy Money Back to top