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Over the past week the yield spread between 2 & 10 year Treasuries has expanded to the widest level seen since May of 2004. As the market vacillates between bailout euphoria and the ugly reality of recession, the yield curve’s volatility has been an obvious output, but so has been an emerging positive slope.

To be sure, falling yields on Bank issued debt, decreased LIBOR levels, and evidence of liquidity creeping back into the commercial paper market are all positive signs that the credit markets are starting to thaw, but history reminds us that the speed at which liquidity returns to normal may prove to be glacial.

In the meantime, the positive slope that is developing in the US yield curve is good for healthy banks and anyone with net cash – borrow short, lend long – remember? Those businesses requiring debt leverage are less attractive however. Cost of long term capital is rising while access to it continues to tighten (spreads widen).

Keith McCullough & Andrew Barber
Research Edge LLC