Pete’s giving a hard hitting presentation to start off February, today he looks at yield curves and what to deduce from them.
Pete explains that because of the way the Federal Reserve conducts monetary policy, the treasury yield curve can tell us a lot about the market’s expectations for economic growth and inflation.
Central banks have three choices when it comes to policy tools:
1) Control the money supply
2) Control interest rates (short or long, not both)
3) The exchange rate
After choosing one policy tool, the other two factors are left to market forces.
The Federal Reserve chooses to control short-term interest rates, allowing the observation of long term rates to give us insight into expectations of future economic growth and inflation.
The current yield curve anticipates modest economic growth 1-2% for the foreseeable future. For inflation, the expectation is also modest, 1.3-1.6% per year over the next 5-10 years.
Looking at the 2 year treasury yields is the equivalent of the markets expectation of the average Fed Funds rate for the next two years.
Pete’s trade idea for today looks at the 2 year, 10 year steepner trade, looking to buy 2 year note futures, and sell the 10 year note futures. This trade is looking for the difference between /ZN and /ZT to wide, meaning we are looking for the yield curve to steepen.