At the moment this chart has a pretty classic technical picture.
Firstly we tested and moved marginally below the lows posted in January and March this year (Low was 3.24% compared to 3.28% on 2 prior occasions) and did not quite test the 2003 low at 3.07%.
We then saw a sharp bounce to 3.91% before posting a perfect 76.4% pullback at 3.40%.
In recent days we have taken out the 3.91% pivotal level and accelerated suggesting a re-test of major resistance at 4.29-4.30%. (Sept. 2007 low, Dec. 2007 high and June 2008 high)
If we were to speculate that this move could give us the 270 basis points spread then a 2-year yield at 1.60% would achieve that result. (Not at all inconceivable)
Let us stretch the envelope a little further and ask…what if the 4.30% level was to give way???
Such a development would actually complete a very well defined double bottom formation that would target a move towards the highs seen in June 2007 above 5.25%. Quite possibly we would not go that far but a break of 4.30% would look to be material and suggest a decent move higher nonetheless. By definition that would at least open up the possibility of the curve steepening more than that seen in 1992 and 2003.
While that is not necessarily great on the mortgage market side (Although that does depend on spreads) it could be viewed positively on the bank recapitalisation front. One of the big issues that developed with Japanese banks in the early 90’s was the lack of a steep yield curve (Mainly because the reaction of the authorities was too little, too late and the damage had been done.) As a consequence they eventually had to send money overseas to create a synthetic yield curve (borrow domestically short and lend internationally long while the BOJ took care of the exchange rate)
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