Food For Thought: Ideal Interest Rate versus the Yield Curve

On April 27, FT carried an article which showed that an internal study at the Fed suggested that the ideal interest for the current economic situation was -5%.

Today the 2yr-30yr bond yield spread stands at 325 bp.

According to Across The Curve the highest level reached by this spread was 367bp, when the 2 year bond yielded 3.60 and the 30 year yielded 7.29 in October 1992.

This is an extreme divergence. On one hand, the Fed feels that it needs to go to negative interest rates to prevent deflation.

On the o

ther hand

the yield curve is at one of its steepest levels, ever.

This is a divergence of historic proportions and shows a market which is not balanced.

I am not sure for how long such an unstable state can continue.

However, such imbalances typically do not end well for many market participant
The spread between fixed rate mortgages and 10 year yields has contracted substantially to a level typically seen when the risk associated with mortgages is considered negligible.

This is a result of the Fed’ s policy to buy MBS.

However if the yields continue to move higher, mortgage rates have nowhere to go but up.

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