Watch Swaptions, Not the Yield Curve

Will it be long before business-oriented television programs start displaying the yield curve in the lower right-hand corner of the screen? There is so much else to hyperventilate over these days, what with gold back over $500, energy prices still troublesome, many stock indices behaving in a bullish manner and real estate either bubbling or de-bubbling, depending on the day the question is posed.

But as a Columnist Conversation last week confirmed, the yield curve is important in terms of access to capital. It was discussed again in this space just two weeks ago in the context of which industry groups were affected most. We have every reason to ask why a flattening yield curve, as defined by the spread between the 10-year and two-year Treasury notes, from almost 275 basis points on Aug. 13, 2003, to less than 8 last week, has not produced significant damage to the leveraged sectors of the economy. The answer is that swap rates have not risen to a damaging level; that factor, and not the yield curve, is critical.

Swap Rates

For all of the attention paid to the Federal Reserve's next move, an attention that should not be as necessary as it is, monetary policy does not directly affect the long end of the yield curve. This was always the case, but prior to the growth of financial derivatives, the Federal Reserve could choke off the supply of fixed-rate credit by raising short-term rates over banks' and savings and loans' interest rate ceilings. ...