(Source: Momentum Global Investment Management)
12 July 2020
Source: Bloomberg & Momentum Global Investment Management
What this chart shows
Government bond yield curves plot the relationship between government bond maturity and yield. In a normal world one would expect the yield curve to be upward sloping with investors paid a premium for locking up their money for longer as they are more likely to be subjected to inflation or default. However, it is by no means static and yield curves can flatten or even invert when long term yields drop below short term yields. Here we show the difference between five-year and thirty-year US government bond yields in basis points (100 basis points equals 1%). The chart shows how in the past few months the difference between the thirty-year yield and five-year yield has sharply increased, implying a steepening of the yield curve between these two points. This follows a period of flattening where the difference between the two reduced to just 0.2%. The implication at that point in 2018 was an investor would receive just 0.2% per annum more for locking up money for thirty years compared to five years.
Why this chart is relevant
The steepening of this portion of the yield curve recently is likely due to three key reasons. Firstly, the prospect of longer term inflation resulting from the government and central bank stimulus introduced to support the economy through the aftermath of coronavirus. Secondly, the US government announced it would issue more longer term debt than expected (thus greater supply of those bonds and lower prices) to fund the massive budgetary stimulus. Thirdly, it has been reported the Federal Reserve was purchasing $75bn of US government bonds each day to support markets during the worst periods of the crisis in March and a big scale back in their activity more recently has also contributed to higher longer term yields. These recent moves have brought into question additional policy tools in the US central bank armory, namely yield curve control. Here the central bank targets a specific yield for a given maturity and conducts open market operations as necessary to hit this target. So far, they have been reluctant to embark on this policy which they haven’t utilised since the second world war. However, a surge in borrowing means greater pressure on the central bank to keep borrowing costs low. Time will tell if they adopt such a move.
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