The possibility of global zero per cent interest rates (Zirps) continues apace. What might that do to yield curves?
Simply change the way they work. From a Dresdner note out today:
While ZIRP might be an appropriate measure to face a recession and the strongly disinflationary forces, it should also change the fundamental behaviour of the yield curve shifting from the historically prevailing regime of bull-steepening/bear-flattening into bull-flattening/bear-steepening due to reduced short-end volatility at near-zero levels, the expectations for a long period of low key rates and little to no performance potential of short dated fixed income assets left.
You can see the start of bull-steepening on yield curves here and here.
Dresdner has also provided us with some new charts today — showing just how “regime change”, as they put it, is under way in USD swap curves as well. That would make sense as the US is nearer to Zirp than the Eurozone or UK.
The three scatter charts below plot regressions between the €2y-10y spread and the 2y € swap rate over the past 1000 trading days, on the left, and their US$ and UK£ equivalents to the right. The red dot represents the current spot levels.
You can see that while Euro and UK£ swaps still lie within (or close to) their normal, recent, distributions, US swaps are not. In fact, dollar swaps are, like yield curves, starting to change their behaviour as the US nears zero per cent interest rates.
Is that likely to happen in the Eurozone and UK as well? Dresdner says not yet:
… a shift in behaviour of EUR and GBP swap curve will not be observable until further rate cuts materialise from the ECB and BoE. In case of the UK, however, no matter whether the BoE will choose to get there more quickly or more slowly, a £ 2y outright hedged 2y-10y flattener is in our opinion the best way to exploit the relatively steep curve currently prevailing.
Related links:
Globally Zirped – FT Alphaville
The steepening curve redux – FT Alphaville
Convexed – FT Alphaville
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