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Behind The Curve…

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Advisory Letter: 31st August, 2019


Warning! Some of the following topics discussed are dry as tea biscuits in the desert, but nevertheless should provide a bit more of a technical insight into the current thinking about the market.

We have been focusing a lot on Equities in the past. Let’s talk about yield curves and what’s behind it… 

Yesterday we have made significant changes to the composition of our actively managed strategies. We have exited our position in long term US Treasury UCITS (20+ years) and allocated the proceeds to the ultra short end of the curve (0-1 years). I am sharing these updates, since I think they are also important for our broader client base.

The rationale is linked to the sentiment cycle through which the market went with regards to Fed interest rate policy and their expectations. I have tried to annotate the below chart of the 30yr US Treasury bond yield minus the 1yr T-Bill yield with my interpretation of the driver behind these recent shifts:

Exhibit 1: Shape of the US Treasury yield curve 30yr minus 1year

On 23rd July we allocated around 35% to the 20+yrs US Treasury ETF, and 30year Treasuries were yielding ca. 0.70% above 1 year T-Bills. Over the matter of just 4 weeks, past the post Fed statement that this is just a ‘mid-cycle adjustment’, the market took it that the Fed has ‘fallen behind the curve’, meaning this 25bp cut was not enough, and we need more cuts to stimulate the economy!

There are certain other indicators which point towards tight conditions in the monetary system, which could lead one to infer that the Fed might cut more than expected. For example the differential between the Effective Fed Funds Rate (EFFR) and the Interest on excess Reserves (IOER). This rate went positive for the first time since it was introduced in 2008, at a time where banks didn’t trust that their deposit counterpart would still be around the Monday after Thanksgiving, so Fed introduced the IOER, the rate at which banks can deposit excess liquidity at the Fed.

With EFFR above IOER, that means that banks are actively borrowing at a higher rate than they are depositing, so why would they do that unless there would be – well let’s say stretched – conditions in the money market? 

Exhibit 2: EFFR vs. IOER

My theory is that a positive spread means overly tight monetary conditions, and the Fed is most likely also seeing the same, and perhaps should be looking to reverse this as quickly as possible. It could also point towards hidden pockets of stress in the system, which may result in adverse market conditions along the line.

(Note: those spikes in data are around rate hikes and cuts due to a timing issue between IOER and EFFR Update which is lagging a day)

In Summary:

We maintain our cautious outlook for risky assets over the coming weeks. I believe that there is a higher chance than currently reflected in the market rates, that the Fed will actually over-deliver in terms of rate cuts in the coming months until the end of the year, which in turn will lead to an ongoing re-steepening of the curve. This means that the price of short term bonds will move more favourably than the one of longer dated debt. This move may even get its own dynamic and turn violent should inflation against all current expectations start to increase, thanks to Donald’s tariff tax, but that’s probably more a story for a 2020 newsletter.


‘Behind the curve’ is a fixed income trader jargon depicting that someone is reactive rather than proactive. It is also the title of a fascinating documentary about flat earthers movement in the US on Netflix.



The materials and data contained herein are for information only and shall in no event be construed as an offer to purchase or sell or the solicitation of an offer to purchase or sell any securities in any jurisdiction. Kristal Advisors does not make any representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of the materials and data herein. All opinions, forecasts or estimation expressed herein are subject to change without prior notice. Kristal Advisors and its affiliates accept no liability or responsibility whatsoever for any direct or consequential loss and/or damages arising out of or in relation to any use of opinions, forecasts, materials and data contained herein or otherwise arising in connection therewith.