Hey There Income Hunter,

 

Here’s something that may come as a surprise.

 

As I watch the Fed and consistently book profits based on its (botched) policy moves …

 

The yield curve has become my bread-and-butter portfolio.

 

And I strongly recommend that you take advantage of it for massive gains, as well.

 

The good news is … it’s easy!

 

Now, to understand the yield curve, you need to grasp some bond trader lingo.

 

Don’t worry – it’s anything but boring.

 

I picked this up as a young trader on the Bear Stearns bond desk in the early 1980s.

 

It was fast times and fast trades … and my book at Bear made $60 million in one year, of which I took home a cool $1.5 million – at the ripe old age of 23.

 

This information was also the bedrock of a 25-year career trading bonds for the big banks that took me to London, Geneva and even Shanghai.

 

Of course, I can’t promise you global adventures, but if you get this stuff down you will have the opportunity for huge profits – and quite a bit of fun.

 

So, here are some key items to get you started …

 

• Yield is simply a cooler word for your rate of return. Technically it means the amount of money brought in from an investment. For example, if you purchased the US 2-year note (table below) yesterday and held it to maturity, the investment would yield 2.458% per year.

 

• Basis Point is the equivalent of .01%, so you could also say the 2-year note yielded 250 basis points a year in interest income. 

 

• Yield Curve Spread is the difference between any two maturities within the US Treasury universe of securities that are sold to the public to pay for our $30 trillion in government debt. 

 

      

 

Today I’ll give you insight into how the Treasury and Fed work together because they may be doing some really funky stuff soon …

 

How the Fed Controls the Yield Curve

 

The Fed is an independent entity that is appointed by the US government and must be approved by both houses of Congress.Its mandate is to achieve full employment and maintain stable prices to ensure smooth and consistent business cycles. 

 

The tools the Fed has to work with are (1) manipulating short-term interest rates to either stimulate or depress the economy and (2) print new money via quantitative easing (QE) to inject into the banking system and provide liquidity to the financial system.

 

The Fed’s “Tool Box”

 

The Fed’s target rate (FTR) is the rate the Fed sets in the Bank overnight lending and borrowing market. The Fed will inject money into the banking system if the rate is too high and drain bank reserves when the rate is too low to maintain the FTR. 

 

The bottom line is … the Fed can only directly impact short-term maturities i.e. 0 to 3-years. The long-term maturities 10-years to 30-years are impacted by inflation and demand for 30-year fixed mortgages, which adds volatility and risk to long maturities. 

 

The Historical Impact of the FTR on the 2-year/10-year Yield Curve (YC) Spread

 

Notice, in the illustration below, how the YC pivots based on the extremes of the FTR … 

 

 

• 1990, prior to the dot.com crash, the economy and the markets were overheating mostly due to extremely high equity valuations … 

 

• The Fed hiked the FTR to 9% forcing the short-end of the curve to rates above the 10-year rate. This forced the YC to invert to –45 basis points, meaning 2-year yields were 45 bps above 10-year yields. 

 

• In 2010 as the economy was in a deep recession, the Fed lowered FTR to 0% as it feared the financial system was on the verge of collapse. 

 

• The slope of the curve steepened dramatically as the 2-year yield plummeted to only 10 basis points and the 10-year yield hit 2.90% for a 2-year/10-year YC spread of 280 basis points.

 

The most critical insight to the chart above is that prior to each recession (shaded columns) the 2-year/10-year YC spread inverted.

 

That has been a hot topic lately because it also inverted on April 1 of this year.

 

And I believe we will experience an economic recession in the months ahead.

 

YC Slope Changes and the Impact on Stocks

 

 

Why QE Only Helps the Financial Markets

 

Now, an important point here is that once rates go to 0%, the Fed is given authority to print money out of thin air and inject it into the banking system via quantitative easing (QE).

 

But QE never worked. The problem is the Fed is only able to credit the banks reserve into accounts held at the Fed … 

 

So … the money the Fed prints is used to pay the banks for the bonds the Fed buys from them via QE. 

 

The banks then use the proceeds and turn around and buy replacement bonds from the Treasury and hold on to them until the Fed comes back for more.

 

This is a cash cow for the banks and the funds never reach the consumers who they were originally targeted for.

 

The Bermuda Triangle

 

 

Bring It Home

 

The QE process is exactly what will be used when the Fed will have no choice but to buy as many bonds as it takes to keep interest rates from exploding higher. 

 

I predict the rate will not be much higher than 3% … and you can be sure of one thing:

 

The Fed will wait too long and something will go wrong in the plumbing of the financial system that will force it to fire up the printing press and go back to QE …

 

A lot of people are banking on it.

 

Live and Trade With Passion My Friend,

Griff