Weekly dose of fixed income realism, August 26–30

Weekly dose of fixed income realism, August 26–30 (Part 1 of 4)

Treasury yield curve flattens ahead of FOMC meeting

Interest rates fall

Interest rates fell last week, as the short-term rates fell 2 to 4 basis points (bps) while the long-term rates fell 6 to 9 bps. The tensions about Syria and the high possibility of a U.S. intervention have the markets on edge.

Treasury Yield Curves 2013-08-28Enlarge Graph

Plus, the Treasury saw poor demand for its five- and seven-year notes auction. Demand was the lowest in four years. On the other hand, two-year notes attracted decent demand.

The reason for the drop in demand is the speculation of the reduction in the Federal Reserve’s bond buying program, which would hurt the medium- and longer-term tenors harder than the short-term tenors.1 To fuel the speculation, the Q2 GDP was revised up to 2.5% from a meager 1.7% previously. Tomorrow’s unemployment report may also be market-moving.

The increased proximity of the upcoming FOMC meeting as well as Labor Day and Jewish holidays have kept fixed income markets virtually on hold for the past two weeks. There could be a near-term rush to push deals out before the Fed meets, though external noise from Syria, budget discussions, and improving macro data may move the markets ahead of the meeting and lock issuers out of the market.

  1. Longer maturities have higher duration, so they have higher price sensitivity to a change in interest rates. When interest rates increase, bond prices drop, so the higher the duration, the larger the price drop.

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