Clint Burdett Strategic Conslulting
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Market Risk - Liquidity Risk - Mania - CMTs - Yield Curve - Spreads <top> <Return to Risk>

A proxy for market risk is the end of the day, over-the-counter (OTC) bid price for Treasury securities (3 to 12 month Bills to 2 to 10 year Notes and 30 year Bonds). The New York Federal Reserve calculates Constant Maturity Treasury (CMT) rates each trading day. Constant maturity is an adjustment for equivalent maturity made by the Federal Reserve Board to compute an index based on the average yield of similar Treasury securities maturing at different periods. e.g., 10 Yr notes with different maturity dates sold on the same day.

This CMT yield curve for shows the yields today compared to the same period last year, how the yield is has changed over time. This example is from Value Line showing the 3m to 5Yr CMT spreads are inverted (darker line sloping up from the 5yr).


Yield Curve Example

The yield for security when sold is (face-value + remaining interest payments to the buyer to maturity minus the sale price) divided by the face-value. Therefore yield will change at each sale. In a stable market CMT rates are index value where a 10 Yr Note with sold 18 months from maturity should have a lower yield for the buyer than for a buyer purchasing a 10 year note with 9 years to maturity. Shorter term CMT rates are normally lower than long term rates, the thin line in the example above. But if OTC buyers demand a higher yield for the shorter term CMTs, sellers must let the price fall. Since each sale is discrete, the reasons the buyer and seller agree are personal.

The Federal Government sells its securities at auction to raise cash. Buyers of Federal securities pay more for a safe haven investment when the risk of market volatility is high (thereby decreasing their yield) or buyers pay less during predictable economic expansions (demanding higher yields at Treasury auctions).

Then, individuals buy or sell those securities in the open market, which reflects daily the public's judgment on growth expectations versus market declines, i.e., market risk. In normal times, shorter term yields are less (the OTC price is closer to the face value of the security)) than longer term yields (need the interest cash flow over time). The end of the paper's term (time remaining) will influence the open market price and CMTs blend yields for a bill, note or bond with different times remaining. The individual sale marks just the yield of that sale. CMT yields aggregate the trade results, hence 1000s of buyers and sellers.

"When bond prices are high — signaling strong demand — yields, the interest paid to a bond holder, fall. Strong demand signals a decline in economic-growth expectations among investors, who wish to lock in future gains by owning bonds." (Denton, Market Watch, 7/8/21)

Traders simplest choices are:

If shorter term yields are rising in an “inverted yield curve”, which can signal an impending recession, as the Value Line team concludes, investors "often shun shorter-term paper out of fear business conditions will continue to deteriorate" and buy longer term paper as yields are falling relative to short term yields to protect cash for duration of the downturn.

Restated, when the over-the-counter yields for CMTs converge, shorter term yields rise (prices fall) and long term yields decline (prices rise). There is more uncertainty about making long term commercial commitments, hence converging CMT yields converging are a proxy for increased market risk.

Buyers are willing to pay more to preserve cash in a safe investment where they perceived business conditions will deteriorate.

Sellers have more reason in the open market to seek cash, such as: shifting cash to better investments, executing a plan, hedging against liquidity risk (you need more cash in the bank) or moving to Government paper early (worrying a "bubble will burst" - get out of X now and protect your cash). If you ever worry about US Government paper liquidity, stop reading this and hoard food.

The worst case: during that 2007-2008 financial crisis, the TED spread was the measure of credit risk to borrow cash, comparing very short term yields, the difference between the interest rate on short-term US government debt and the interest rate on interbank loans. In September 2008, the Ted Spread spiked and commercial credit was very, very expensive or not offered. In mania, you cannot get credit to borrow even short term, there are runs on financial institutions and the government becomes the lender of last resort. Briefly in September and October 2008, the mid- and long-term borrowing in commercial markets had essentially "shut down." CMT yields collapsed once the Fed as the lender of last resort, moved to restore favorable credit conditions and CMT spreads slowly returned to normal.

What behavior causes a buyer of CMTs in the open market to choose the shorter term paper over a longer term or vice versa?

  1. Investors are selling stocks, shifting their money to bonds to preserve cash, to avoid future stock losses, especially where an Administration could create a market loss for short seller advantage or to reduce personal interest costs (OMG - elite corruption - at 67, I have never said that).
  2. Speculation that rates will fall more and increase the price of the Federal paper OTC, i.e., the Fed lowers the discount rate, a sellers investment profit decision.
  3. Don't tie up cash long term, wait for the shorter term paper to mature at face value, a near term cash flow decision.
  4. Perceive cash in Federal paper long term until GDP growth accelerates again.
  5. Maneuver to benefit from an eventual decline. When 2 year CMT Notes pay more interest than 10 Year CMTs, the recession in 11-24 months off.
  6. and on and on.

My observations of economic behaviors suggested by CMT yield spreads (more nuanced than a "flight to safety" used by the media, derived from my consulting years planning strategic use of funds):

I still have trouble getting my head around yield curve analyses, too simple a measure for a very complicated economy and behavior. It is just a technique to assess Treasury paper buyers/sellers' perception of risk - a leading indicator for GDP shrinking.


The San Francisco Fed considers the 3m T Bill to 10 Year Note spread a slightly better leading indicator of a recession.

Chinn from Econbrowser discusses the 5yr - 3m spread (proxy for long-term assets purchases) as a leading indicator.

Hamilton from Econbrowser cautions reading too much into inverted yield curves, using a 3m-10 analysis.


Authored by Clint Burdett Strategic Consulting
A Practical Guide to Strategic Planning
©Arthur Clinton Burdett III- All Rights Reserved

All the data used to produce my graphs for my
observations on the economy are available to the
public from USA Government sources, use of which is
not protected by a copyright.

For St Louis FRED charts, see citation on the charts
or FRED page for the source and any restricted use.

All graphs indicate the data sources.

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