Interbank Yield Curve: 28th September 2010

It has been a while since I posted on the yield curve, the main reason was that I lost my daily treasury letter from Bank of Scotland when all of their reporting went back to the UK and the daily replacement by Lloyds didn’t offer sufficient time-line to give a full curve.

The interesting thing that has happened in the interim is that the rules regarding forward rate prices between mortgage rates and Euribor rates has disconnected, in the same way that the ECB and Euribor disconnected in 2007, by this I mean that it is fascinating to see the established relationship end but the implications are horrifying for borrowers because it has meant that their monthly payments have gone up at a time the ECB is keeping rates low for the purpose of loosening up the financial cogs.

Take a look at the difference between February of this year and today, we can see that the long term rates are coming down and that flattening of the curve means two things: the ‘new normal’ is predicted to be one of sluggish growth, but it also sets the stage for price increases via inflation as money becomes very cheap and it tends to lead to liquidity reserves that can then find their way on the market rapidly. That is not happening at present, money supply is rising rapidly but there is no multiplier thus far, but that doesn’t mean it can’t happen.

What we are seeing is a comfortable connection as far as the one year mark, the reason the recent blue line is higher is due to the premium on interbank lending at present (everybody has to pay slightly more of late), the disconnect however, is from 12 months on at which point we see the significant shift in the yield curve and it looks set to flatten. This is coming at the same time as we see the 30yr German bond trading at a whopping 130 with a yield of c. 2.6%!

So the options at the moment are to run in fear to quality (Bund), or take risk, the German pricing is telling us that currently fear reigns supreme, but when that ends (perhaps ‘if’?) then we should see a significant wave of liquidity in the real economy, I just can’t tell you when. Perhaps it won’t happen? Banks around the world are extracting more and more out of the real economy, we’ll look at an Irish example.

We can see that the yellow line is significantly higher on the chart than the light blue line, that represents the shift in the mortgage rates versus the interbank rates. I’ll do one with arrows to make the picture clearer.

The gap is getting bigger, meaning banks are taking ever more money in and the recent lending figures by the IBF show that they are not in turn lending that money out. So the yield curve is working to the banks favour, normally this would be a golden opportunity, except for the fact that they are finding it expensive to raise funds because there is a premium on Irish banks and for that reason the gap is not as big (in reality) as it looks on paper. However, the fact remains that margins are going upwards and because of that the people who took long term fixed rates are going to win out because rates are going up independent of ECB.

Ireland has been a low rate country (versus the Eurozone) and now we are moving mid-table and in the future we will move higher, risk on Irish property will reprice in the same manner that our national bonds are repricing, although for slightly different reasons.

The lesson to take from this are: Fixed rates are yesterdays news, banks have jacked up the prices too far to make sense, the best time to move was in Q1 of 2009. Trackers are sitting pretty, don’t move off one without a really good reason, and lastly, variable rate holders are in for more pain, for them rapid deleveraging may be the only solution.

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