It's extremely easy to get very deep in the weeds very quickly when talking about what's happening in the market for government bonds. "Steepening yield curve," is one of those signal phrases that informs 99% of the population that what follows will be intelligible or uninteresting, or both. But recent moves in the market for government debt have exercised insiders. Across the Curve's John Jansen got the blogosphere's attention, for instance, by writing:
Maybe the final climactic event is upon us. Maybe the final bubble to burst is the US Treasury market and maybe we are on the verge of a financial Krakatoa which will realign financial markets.
Whatever the case it feels like the calm before the storm and we are about to embark on another interesting expedition.
Ok, then. Best to try and figure out what's going on.
Very basically, the government is having a much easier time selling short duration debt than it is long duration debt. Both central banks and private investors are piling into shorter maturity bills and notes. The question is why. Potential explanations include waning interest from buyers who were seeking safety but who now feel comfortable buying things other than government debt, and investors nervous about repayment prospects. The main factor is related to both of these explanations -- investors are anticipating a recovery, and are anticipating that recovery will bring inflation.
Those expectations mean that interest in longer maturity bonds will decline until rates on those bonds rise; investors need to be compensated for the expected deterioration in the value of the dollar over the life of the instrument. The downside here is that the Fed has tried very hard to keep long-term interest rates low in order to increase investment and juice the economy, and the rise in long-term rates is pushing up the cost of things like 30-year mortgages. On the other hand, a little inflation and dollar depreciation would be healthy for the economy, provided that it didn't lead to a damaging spike in commodity prices.
But the real silver lining to the steepening yield curve is the effect on the banking industry. It certainly looks like we're committed to propping troubled banks up while they attempt to earn their way out of this mess, and a steep yield curve is good for bank earnings. So, you know, bright side!
Recommended additional reading: Brad Setser
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