Long Term Perspective

The Treasury stopped issuing 30-year bonds in 2002; as the average maturity of outstanding bonds decreased, the Treasury began to calculate the average yield on 25-year bonds. On June 1, they stopped calculating 25-year bond yields and shifted to 20-year bond yields because the average maturity of bonds continued to drop (since we didn’t have new 30-year bonds). Since market players do not follow 20-year yields, but 30-year yields, the Treasury continued its calculation of 30-year yields based on “daily linear extrapolation factors”.

The average spread between the 30-year Treasury bond yield and the federal funds rate was 184 basis points in the 1990s, a far cry from the negative 189 basis point spread averaged in the 1980s. One would expect long term rates to be higher than short-term rates since a liquidity premium is built into the normal yield curve. The 1980s was an unusual period with high interest rates and two back-to-back recessions. The year 2000 also brought unusual behavior to the 30-year bond. Since the Treasury announced that it would reduce the quantity of 30-year bonds offered in the market, a premium developed for these long term issues causing their prices to rise and their yields to fall (below the federal funds rate). The Treasury went even further in October 2001 when they announced the indefinite suspension of new 30-year bonds. In August 2005, the Treasury announced the resurrection of the 30-year bond – and the first issue was auctioned in February 2006.

The spread between the long bond yield and the federal funds rate averaged 201 basis points from 2000 to 2006. The spread averaged 135 basis points in 2005, but fell sharply in 2006 to minus 9 basis points.

Short Term Perspective

Long bond yields did not move in tandem with other yields between 2003 and 2006. Yields rose slightly in 2003, but remained relatively stable even when investors were expecting the Fed to start raising the fed funds rate target from its historically low rate of 1 percent in June 2004. In fact, as the Fed raised rates continuously in 2004 and 2005, the long bond yield declined rather than increased on expectations of slower economic growth and lower inflation. During late 2005 and early 2006, the 30-year T-bond rates did rise but not as much as shorter maturities. As the economy slowed during the second half of 2006 long bond rates eased. Rates firmed in the second quarter of 2007 in tandem with stronger economic data but dropped during the second half of the year over flight to quality from subprime concerns and on weaker economic growth.

The long bond yield average declined 25 basis points in November to 4.52 percent.

Values shown reflect monthly averages.