Nov. 17 — Treasury 30-year bonds rose for a fourth day after a report showed producer prices increased less than forecast in October, confirming the Federal Reserve’s outlook for subdued inflation...Longer-term government debt extended gains posted yesterday after Fed Chairman Ben S. Bernanke indicated in a speech that low inflation will allow policy makers to keep interest rates near zero for an extended period.
Below we show a comparison between the Fed funds target rate and 5-year U.S. Treasury yields .
The first point is that the trends are similar. 5-year yields and the overnight Fed funds rate trend broadly together.
The second point is that when the funds rate first approached 0% in December of 2008 5-year yields were closer to 1.5%.
We will shift to the chart below right so that we can make our next point. The chart compares the share price of Japanese bank Mitsubishi UFJ and the spread or difference between 30-year and 5-year Treasury yields.
MTU reports earnings over night and will likely discuss an impending and expected equity offering so the share price might be volatile today. Our view, however, is sufficiently ‘macro’ to look beyond today’s issues.
When the spread or difference between 30-year and 5-year yields is high the share price of MTU is low. When the difference between 30-year and 5-year yields widens out to roughly 2% then MTU tends to be at or near a bottom. The best long-term place to exit MTU is after the yield curve has flattened to the point where the spread approaches the ‘0’ line.
The point is that with the yield spread near the highs it makes sense that MTU is close to the lows. The argument is that a positive trend for MTU requires a flattening of the yield curve and this can be accomplished in one of two ways- higher short-term yields due to very strong economic growth or lower long-term yields. In other words either the Fed funds rate rises towards 5-year yields or 5-year yields decline back towards the funds rate.
Equity/Bond Markets
Below is a comparative view between copper futures and 5-year U.S. Treasury yields.
We have observed on quite a number of occasions over the past year or so that copper PRICES have been quite close to 5-year YIELDS. Copper was around 3.50 when yields were 3.5%, copper fell to 1.20 while yields touched 1.2%, and after stalling at 2.20 and 2.2% respectively yields rose to 3.0% pulling copper prices eventually to 3.00.
The issue, however, is that these two markets have diverged- substantially- during the second half of this year.
When copper is strong and yields are falling... the mining sector does very nicely. When metals prices are rising and interest rates are declining then the gold miners tend to rise in price. Below we compare the Philadelphia Gold and Silver Index with the ratio between copper prices and 10-year yields.
A rising copper PRICE in the face of falling YIELDS drives the ratio higher which, in turn, creates a sense of momentum behind the gold miners. That has been ‘the trend’ for the past year.
Further below we compare 10-year yields with the ratio between crude oil prices and gold prices.
The argument is that the trend for yields is not clearly up OR down. The trend for yields has actually been almost dead flat since June as the crude oil/gold ratio has tracked sideways. Energy price strength could push the Fed funds rate UP towards 5-year yields while energy price weakness could pull 5-year yields DOWN towards the funds rate. To date the markets appear to be marking time before a decision is ultimately reached.
