A few days back I was discussing the technical dynamics of the long-dated treasuries and suggesting the setup was point to a steepening yield curve. I have been looking for further clarity into this setup and see if the market could provide any further information, specifying looking to see if the market's expectations for the real risk free rate or inflation were rising. The answer appears to be yes.
Taking a step back, yields on Treasury bonds are composed, according to theory, by a component composed of the risk-free rate and an inflation expectations component. Essentially the equation reads like this Risk Free Rate + Inflation Rate = Treasury Yield. The actual equation is more complicated than that, but I want to keep things simple. In any event, it is a decent approximation. Although it comes with certain biases. the advent of Treasury Inflation Protected Securities (TIPS) trading has allowed traders to glimpse on a nearly real-time basis the changes in the inflation expectations and the real yield.
To that end, I looked at the changes in real yield and inflation expectations embedded in the Treasury/TIPS differential to see if traders' and investors' expectations had changed over the last few months. The results appear to be that have, but their expectations appear largely range bound. The following graphs shows the year-on-year difference of the real yield and inflation expectations for varying durational instruments. I use the year-over year difference to smooth out any possible seasonal influences.
5-year
10-year
20-year
30-year
What appears to me that is going on is that the changes in the real yield are most pronounced at the higher end of the curve, albeit still range bound. The shorter end of the curve shows the changes in the real yield remaining flat (does this suggest that traders see better growth 20+ years out? Maybe). As for inflation expectations, most of the near term changes in expected inflation appear to be ticking up somewhat. However, these rates also appear more range bound than not.
So what is going on? Maybe it is just a technical move being borne out of aggregate traders' actions. As a recent article at Minyanville states.....
........ But history has repeatedly shown since the beginning of the financial crisis that the exact opposite is true. US Treasuries do not rally under QE. Instead, they suffer mightily.
Nowhere is this phenomenon more pronounced than the long-term area of the US Treasury market. A look back over the last five years clearly demonstrates this point. It was in March 2009 that the Fed expanded its still-developing QE program at the time to include Treasury purchases. Over the next year through March 2010, 30-Year US Treasury yields ballooned by over 1.25 percentage points, peaking on the very last day of the program in March 2011. When QE2 was revealed to the market later that year in August 2011, 30-Year US Treasury yields once again jumped by 1.25 percentage points over the next several months. And in recent months, we’ve seen 30-Year US Treasury yields rise by 70 basis points once expectations for QE3 began to build in the summer of 2012, including 40 basis points since it was officially announced back in mid-September.
Taking a step back, yields on Treasury bonds are composed, according to theory, by a component composed of the risk-free rate and an inflation expectations component. Essentially the equation reads like this Risk Free Rate + Inflation Rate = Treasury Yield. The actual equation is more complicated than that, but I want to keep things simple. In any event, it is a decent approximation. Although it comes with certain biases. the advent of Treasury Inflation Protected Securities (TIPS) trading has allowed traders to glimpse on a nearly real-time basis the changes in the inflation expectations and the real yield.
To that end, I looked at the changes in real yield and inflation expectations embedded in the Treasury/TIPS differential to see if traders' and investors' expectations had changed over the last few months. The results appear to be that have, but their expectations appear largely range bound. The following graphs shows the year-on-year difference of the real yield and inflation expectations for varying durational instruments. I use the year-over year difference to smooth out any possible seasonal influences.
5-year
10-year
20-year
30-year
What appears to me that is going on is that the changes in the real yield are most pronounced at the higher end of the curve, albeit still range bound. The shorter end of the curve shows the changes in the real yield remaining flat (does this suggest that traders see better growth 20+ years out? Maybe). As for inflation expectations, most of the near term changes in expected inflation appear to be ticking up somewhat. However, these rates also appear more range bound than not.
So what is going on? Maybe it is just a technical move being borne out of aggregate traders' actions. As a recent article at Minyanville states.....
........ But history has repeatedly shown since the beginning of the financial crisis that the exact opposite is true. US Treasuries do not rally under QE. Instead, they suffer mightily.
Nowhere is this phenomenon more pronounced than the long-term area of the US Treasury market. A look back over the last five years clearly demonstrates this point. It was in March 2009 that the Fed expanded its still-developing QE program at the time to include Treasury purchases. Over the next year through March 2010, 30-Year US Treasury yields ballooned by over 1.25 percentage points, peaking on the very last day of the program in March 2011. When QE2 was revealed to the market later that year in August 2011, 30-Year US Treasury yields once again jumped by 1.25 percentage points over the next several months. And in recent months, we’ve seen 30-Year US Treasury yields rise by 70 basis points once expectations for QE3 began to build in the summer of 2012, including 40 basis points since it was officially announced back in mid-September.
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