US Bond and Interest Rate Futures Spreads, US Interest Rate curve inversion

It’s been a while since my last post. I’ve been busy but I will try to write more frequently. Today, I’m going to talk about US interest rates and bonds. In one hand the US economy is performing pretty well, at least for now. The GDP is good but not as the government promised. The employment is strong but the figures show that it’s been driven by part-time jobs and this doesn’t help in the long term. The bank earnings usually reflect the economic performance, and they have reported better than expected profits. On the other hand, the Federal Reserve is tightening. The debt hasn’t been reduced. The protectionism won’t help. This is not new and I believe that you have already read about this.

Fed’s Williams warned earlier this week that the yield curve inversion can be seen as a warning signal. An inverted curve has always been a recession signal.

How can we understand if the curve is flattening or steepening?

Basically, if we simplify the process and we only do the yield difference between 2 different products or the same product with different maturities. If the difference grows over the time, the curve is in a steepening process. If the difference decreases, we will see the curve flattening. Once we understand this we can have a look at different markets:

US Bond Spreads

    5Yr T-Note  - 2Yr T-Note futures spread, Barchart 

In this case, I’ve chosen the price difference between the 5 Yr T-Note and 2Yr T-Note futures. It’s not as intuitive as if I had taken the yields but it’s easy to understand. Obviously, an investor would look for a higher return on a long duration investment than in a short duration investment. If I have 2 assets with a different duration that offer the same return, I will choose the short duration asset. The reason behind this is that I would be able to compound the returns. When there are good news and the economy is doing well, the traders sell the bond futures and considering that the longer duration is more volatile the spread between them will increase. In our case, we can see that the 5Yr-2Yr spread is decreasing.

    10Yr T-Note  - 2Yr T-Note futures spread, Barchart 

The 10-2Yr spread is decreasing and it’s very close to the 8 year low (12.71)

3 month Eurodollar futures

     Eurodollar Sep18-Jun19  spread , Barchart 

This is a 6-month spread in which is going up. You can think that the traders are discounting more interest rate hikes during 2018.

    Eurodollar Jun19-Jun20  spread , Barchart 

This is a bigger spread that covers 12 months. It’s more volatile than the previous one and it´s testing an important support. The most interesting thing is that shows how the interest rate curve is flattening between 2019 and 2020. 

   Eurodollar Jun20-Jun21 spread , Barchart 

If you were surprised with the last chart, take a look at this. Basically, the curve is flat between 2020 and 2021 and probably it will be inverted in the coming weeks or months.

Eurodollar quotes 

     Eurodollar futures quotes, CME

I would like to recommend this short article that offers a different perspective with the same conclusion:

https://www.ft.com/content/f24fbc80-431c-11e8-803a-295c97e6fd0b

Highlights and future questions

All the experts are warning about a possible recession between 2020 and 2022 and as we have seen the curve is inverting at this point. How will the central banks react? Will the Fed choose between fighting inflation or the job market? How will the governments try to reduce the debt? What will happen with the private debt? 

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved