Fixed-income investors often ask for the best way to forecast interest rates or to analyze the direction of the bond market. Obviously, there is a lot of information that may be followed and several pertinent items are included in the table that accompanies this column each week. Perhaps it will prove beneficial to examine the table this week and next, and to suggest other data for those who are interested.
First off, all marketable fixed-income securities -- whether they be money market, corporates or municipals -- have a relationship to U.S. treasuries. These securities are priced at either a basis point spread (a basis point is one one-hundredth of a percentage point) from treasuries or, in the case of municipals, at a percentage of a treasury. This relationship changes with various factors, such as the supply of and the demand for new issues, inflation, Federal Reserve policy, tax changes and so forth.
For this reason, the table includes five separate treasury issues with various maturities: the 6-month and 12-month T-bills, followed by the 2-year and 10-year notes and the 30-year bond.
The yield on the two T-bills is stated in "coupon equivalent" form to enable the reader to construct a treasury yield curve and to compare them against other issues. Thus, we are talking about "oranges and oranges" when all of the yields are presented in coupon form.
Many times you have heard reference made to yield curves, that it is "flattening," or it is "steepening." A yield curve is constructed by placing maturities on the horizontal axis, and yields on the vertical axis. By plotting the yields at each maturity, and then connecting each dot with a line, we arrive at a yield curve.
It must be kept in mind that this yield curve only gives you a picture of a yield at a given moment. In the marketplace, these securities are being traded every minute; therefore, their prices and yield vary greatly over the course of a day.
If a yield curve slopes upward from left to right, it is considered a positive sloping curve. When it slopes downward from left to right, it is considered a negative sloping curve. And if it is horizontal, it is a flat curve.
A positive curve is the more normal curve and occurs generally when monetary policy is on the "easy" side. The negative curve occurs in periods of high inflation and is caused by a "tight" monetary policy. A flat curve denotes a transition from one interest rate cycle to another.
Next week, we will finish examining the contents of the table, which will include information on the AA utility and tax-exempt data. Again, there is endless data that can be scrutinized and everyone has his favorites. Pick out information that is readily available and easy to understand. It will make you a more educated bond buyer.
James E. Lebherz has 28 years' experience in fixed-income investments.