The Yield Curve Curve 010813

When you think about the interest rate yield curve, how do you picture it in your head? Is it a curve showing current rates for various maturities?

When you think about interest rates over an extended time frame, how do you picture it in your head? Is it a time series of one single maturity interest rate like the “Ten Year” shown with time along the x-axis and the rates as the y-axis?

My general impression is that the majority of people who think about the yield curve (not something everyone thinks about mind you) typically think about it in two dimensions.

As an investor focused in the MLP space I am constantly watching the yield curve. There is a generally held belief that “MLPs will do poorly in a rising interest rate environment,” and while I don’t think it is that cut and dry I view “risk free yield” as a competing/alternative product for future yield based investors buying MLPs (if you could buy a 30 year U.S. Treasury yielding 8.26% like you could in December of 1990 you would logically want a higher rate of return/higher yield from an MLP equity investment due to its higher risk).

Additionally MLPs tend to use debt as a large part of their capital structures so in a big picture sense when interest rates increase the debt service burdens will logically also increase (higher debt service then translates into slower distribution growth to the equity investors). Of course that concept also applies to any company that has debt on its balance sheet. So in a general sense I view a rising interest rate environment as a headwind for equity investments, which makes me want to carry a short position against rising rates as a portfolio hedge, which begs the question “when do you start the short position?”

What does the full yield curve look like over time?

View 1

YCC View 1

View 2

YCC View 2View 3YCC View 3View 4YCC View 4View 5YCC View 5

Note: The five views are all the same data just shown in slightly different ways, angles, etc. All data is just point in time data for the dates shown and does not include all of the interim information so it is a simplified dataset. Historical rates that show up as zero prior to 12/31/06 are due to lack of data from Treasury (i.e. no 30 Year U.S. Treasuries were quoted at 12/31/02 through 12/31/05 because the government wasn’t issuing them). View 5, the Surface Chart, excludes the 1 Month maturity due to lack of data prior to 12/31/01. Here’s a pdf file with larger versions of the charts: The Yield Curve Curve

Oversimplified Observations / Questions

Did seeing the yield curve over time in a three-dimensional way change your perception of interest rates or recent interest rate history?

Since the beginning of the data set the full yield curve has generally been in a downtrend (generally a series of lower highs as far as rates). This long-term trend of generally lower long-term interest rates has been in place for a very long time (since 1981). Can that trend continue? Looking at View 2, it looks like the short end cannot get lower (generally assuming that interest rates have a lower bound of 0.00% except for very extreme circumstances). The long end of the curve came down in sympathy with falling short rates throughout the fun time that was 2008 and the curve steepened and then continued to steepen during 2009. Since then it seems that everyone has wanted to own more and more U.S. Treasuries as the long end of the curve has continued the downtrend in rates, even helped by the Federal Reserve continuing to buy $45 Billion per month of U.S. Treasuries under the expanded QE3.

There is a massive amount of money sloshing around in the U.S. Treasury Market. When the Federal Reserve stops buying U.S. Treasuries under QE3 what happens next? Treasury Yields Close to 8-Month Highs Before Auctions

Jeffrey Gundlach, CEO of DoubleLine Capital, doesn’t think there is a bubble in U.S. retail investor ownership of Treasuries (as per his 1/8/13 conference call, a replay may eventually show up here, slides at ZeroHedge), so most of the investors in the U.S. Treasury market must be smart money / institutional. Mr. Gundlach is also in a big picture sense “not negative on U.S. Treasuries” and “likes the U.S. Ten Year at a 2% yield.” So he doesn’t seem to think we are in an increasing long-term interest rate trend yet but he did say the he thinks the 30 Year Treasury rate will be higher in three years and he would be surprised if the 30 Year Treasury Rate is lower in one year. He also thinks that the 1.39% yield on the Ten Year Treasury was probably a bottom in that rate.

If/as the economy improves, the Fed stops buying Treasuries and then at some point starts a tightening cycle (raising the short-term Fed Funds Rate), what happens to the whole yield curve?

If the trend of lower long-term interest rates then reverses and turns into a long-term trend of higher long-term rates what happens? Rates going up means Treasury prices going down so will decreasing prices cause investors to sell Treasuries? If a large amount of money then comes out of the U.S. Treasury market where will it go next? Bond funds manage a large amount of money so it’s in their own self-interest to redeploy that money into other bond classes so they can stay in business but would some percentage of the U.S. Treasury investments that represent individual investor money possibly shift into equities?

Nobody knows the future. It may be too soon to start a short treasury position but I will be watching for “higher lows” in long-term rates in the ever shifting yield curve (no need to rush) and while it has been a great run since 1981 (just ask Bill Gross) we must be getting closer to the end of the downtrend…

Please feel free to fire away with any comments as the only thing I do know is that I don’t know.

About Philip Trinder

President of MLP Protocol, investor, trader, and proponent of Master Limited Partnerships.
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2 Responses to The Yield Curve Curve 010813

  1. Hello Mr. Miller,

    Thanks for reading and commenting! I share your concern about the impact of rising interest rates on the amount of money that the government has to spend on interest rate payments (just like the concern for companies discussed in the post). Another data set I would love to put together is the amount of outstanding government debt at each maturity along the curve and also show that data over the same time period, in a general sense we know that the total amount of outstanding U.S. debt has been increasing while at the same time the rates have generally been decreasing (although I think a HUGE amount of the debt is being financed in the short end of the yield curve, which could turn problematic).

    So the supply of U.S. debt has been increasing while the price has effectively been increasing (i.e. interest rates coming down) so that must be being driven by growth in demand for U.S. debt (thank you China). Let’s hope we can continue to find enough demand for the growing supply of U.S. debt.


  2. Elliot Miller says:

    When rates start to approach 3% for the 10 year note, we won’t be able to pay the interest on the national debt without massively inflating the USD.At that point crude oil prices, stated in USD, will also dramatically inflate so this will help upstream MLPs and midstream oil based pipelines and processors (refiners). That will also cause increases in NGL prices which will help rich gas based midstream MLPs and upstream NGL producers.

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