Monday, June 24, 2013

Shape of the yield curve adjustment impacted by bond buying pattern

Here is how the treasury curve shifted over the past two months (through today).

The obvious question is why has the sell-off been most acute in the 7-10yr range (the 7-year yield has increased by 90bp)? And why have the bonds in the 20-year range been a bit more stable. The answer has to do with the Fed's buying patterns.

Source: NY Fed

Maturities where the Fed has been most active are the ones which are more vulnerable to this correction. Those are the bonds whose prices the Fed has been supporting (aside from treasury bills that are now used as safe-haven). As the support diminishes, the bond pricing adjusts to post-QE levels. (Note that the bucketing used by the Fed doesn't match the bond maturities in the first chart precisely and the pattern is obviously not exact - yet the relationship is still visible). This tells us that a great deal of the fixed income pricing to date has been determined by the monetary expansion rather than the fundamentals of the markets.
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