All points of the yield curve ended the week at the top of the most recent range. This marks our third trip to .75% on the two-year in the last month and a half, with both of the other spikes being followed by quick rallies back to the .5% handle. The Fed’s stance remains unchanged, and until any real change comes on that front the short-end will remain anchored below 1%. Is this latest spike in rates the beginning of a new longer trend, or are we due for another rally in bonds that slaps rates back down?

Given the Fed’s policy and role in the market as the largest holder of Treasury securities, it is difficult to judge if there should be a safety trade accompanying the problems in Egypt. Treasurys were well bid during the worst days of the Euro-crisis, as money flowed out of Eurobonds into US Treasurys. Granted, the same trade wouldn’t be applicable to issues in Egypt, but the traditional derisking move, sell stocks and buy Treasurys, was absent this week. The longer the Fed remains floored, the more risk becomes distorted and mispriced.

Supply next week could weigh on the market and move rates higher. The Treasury will issue $32B, $24B and $16B in 3-, 10- and 30-years next week, not a huge number by today’s standard where $100B+ weeks are the norm, but heavily weighted toward the long-end of an already very steep curve. More pressure on the long-end could push yields above the all time closing high in 2s to 10s of 2.91% from back in February 2010. The 2s to 30s spread however set a new record this week, closing over 400 basis points on Monday for the first time on record. With new 10- and 30-year paper coming to market next week, the street will be watching closely to see if the recent selloff is enough to attract buyers at these levels.

The spread between two-year and ten-year Treasuries is 2 basis points from the all time high.

And the spread between two-year and thirty-year Treasuries is currently at the all time high.

The Fed is dedicated to finish QE2 in June, but the bond vigilantes may be sending a signal with this week’s action. Rates are where they are almost entirely because of the Fed, (do I sound like a broken record?). If the Fed decides not to increase their purchases and the QE era is in fact over, higher rates are coming.

Have a great weekend. 

Cliff J. Reynolds Jr., Investment Analyst