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10-30 spread hits record high

The spread between 10 and 30-yr Treasury bonds has hit an all-time record high of 114 bps, according to my quick review of history. This record curve steepening is not showing up in other areas of the curve, however, and the spread has widened sharply in the past week or so. This could be a signal that 10-yr bonds are benefiting from unusually strong demand, perhaps because the Fed has presumably leaked its intention to reinvest income and principal on its MBS holdings, rather than allow them to reduce its balance sheet. That's a tempting conclusion, but I think there are other things at work as well. 

The curve has been steep for some time now, and that is a classic sign of accommodative monetary policy and, and as such the curve presages a) an economic acceleration and/or b) rising inflation. Either one of those would be consistent with a widening of the 10-30 spread. 

It might also mean that those who were speculating on rising 10-yr yields have had to buy back their short positions, for fear that this presumed change in Fed policy will delay the rise in 10-yr yields. 

Whatever the case, a much steeper curve at the long end almost surely is a vote of no-confidence in the deflation scenario. If deflation were really a strong possibility, then investors would be buying the 30-yr and selling the 10-yr, betting on a flatter yield curve and locking in 4% yields on 30-yr Treasuries.

As I've said many times in the past, anything that diminishes the risk of deflation is automatically bullish from an equity investor's viewpoint. So the bottom line here is that the steepening of the long end of the yield curve is a positive, especially considering how bearish market sentiment appears to be, and how pervasive deflation fears appear to be.

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