All articles 187

10 19 2015 | by Victor Xing | Capital Markets

Which part of the Treasury curve is most important to bond investors?

The 10 year Treasury note is the most liquid part of the Treasury curve.  It is also correlated with 30 year conventional mortgage rates.

Different tenors of the Treasury curve vs. federal funds rate
Different tenors of the Treasury curve vs. federal funds rate

However, 7 year part of the Treasury curve has a duration profile that is closer to the new origination Mortgage-backed security.  Investors tend to focus on 5 year and 7 year rates when trying to hedge out interest rate risk of mortgage bonds.

 

The “brief absence” of 30 year part of the Treasury curve

The 30 year Treasury bond issuance was suspended between 2002 and 2006, as the U.S. government used budget surpluses to pay down Federal debt in the late 1990s.  Also, the 7 year note issuance was absent until 2009.

Therefore, financial market participants for a number of years could only focus on 10 year on-the-run Treasury notes as the expression of longer-term borrowing cost.  Many people subsequently follow 7 year and 30 year part of the Treasury curve (7 year note is the proxy for TY Treasury Futures due to cheapest delivery bonds being between 7 to 8 years, and 30 year bond is essential in yield curve strategies on Federal Reserve policies), but I believe financial reporters have formed a habit of just focusing on the 10 year sector

SIFMA data on issuance across the Treasury curve
SIFMA data on issuance across the Treasury curve

Fixed income investors focus on all part of the curve

2 year: most sensitive to upcoming Federal Reserve policy decisions
3 and 5 year: sensitive on Federal Reserve’s future rate path (instead of “when will the FED liftoff rates,” it would be “how many FED hikes by 2018 or 2019?”
7 year: CTD of TY futures and most sensitive to risk-off rally (when equities under-perform)
10 year: also known as the intermediate part of the Treasury curve – highly liquid.
30 year: least sensitive to FED interest rates policy, but it is more sensitive to inflation expectations.  It is also sensitive to FED unconventional policy – if FED decides to sell assets, 30 year part of the curve will under-perform

Next article10 19 2015 | by Victor Xing | Central Banks

Are central banks responsible for credit cycles and credit crises?