MONDAY DECEMBER 21, 2009

Double Diamonds

On the ski slopes, the double diamond sign indicates that the ski run ahead is very steep and difficult.  Perhaps we can apply that to the current Treasury bond yield curve.  The 2 year note currently yields .86% while the 10 year note yields 3.67%.  The difference, called the spread, is 281 basis points, up from only 145 basis points at the beginning of 2009.  The 281 basis points is  a record for the steepness of the yield curve.  Double Diamonds indeed!  In addition, the spread between the 10 year Treasury note and the 10 year Inflation Protected 10 year note (TIPS) is now 2.25 percentage points, the widest it has been in over a year.

What does this all mean?  It suggests that the bond market is beginning to build higher inflation and interest rate expectations into the future.  With massive debt issuance coming down the pike, and interest rates at 0% for the Fed's "extended period", the bond market is telling us that inflation is what they are worried about, not deflation.

If this trend continues, the equity markets will face a more difficult time, as higher rates will help the dollar and hurts cash flows into stocks.  The steepness of the Treasury curve suggests that stocks might be facing a Double Diamond 2010!

POSTED AT 1899-12-30 14:46:00.0

KEN ENTENMANN, CFA
SENIOR VICE PRESIDENT AND
THE DIRECTOR OF INVESTMENT MANAGEMENT SERVICES

Ken is a Senior Vice President and the Director of the Trust and Investment Services at Alliance Bank, N.A. He has 23 years of investment experience and oversees the management of assets totaling $1 billion. He holds a B.S. in Applied Economics and Business Management from Cornell University and an M.B.A. from the William E. Simon Graduate School of Business Administration at the University of Rochester. He has also earned his Chartered Financial Analyst designation. He is a member of the Executive Committee of the Trust Division of the New York Banker's Association. He is also a director of the Central New York Community Foundation.

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