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Richard Suttmeier is the Chief Market Strategist at

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February 16, 2010 – The US Treasury Coupon Curve

The Federal Funds Rate versus the Discount Rate! Dissecting the US Treasury Coupon Curve.
Looking at the Federal Funds Rate and the Discount Rate since 1990 – the Discount Rate was
below the Funds Rate until June 25, 2003. We successfully exited the 1988 to 1992 Housing Situation
with the funds rate at 3% from Sept 4, 1992 to Feb 4, 1994, which is an “extended period.”
Fed policy mistakes since 9/11 included pushing the funds rate below 3% on October 2, 2001. As
this was done commodities price charts including gold and crude oil were bottoming.
The Discount Rate was below the Funds Rate until June 25, 2003 when the Fed stupidly cut the funds
rate to 1% leaving the Discount Rate at 2%. This was the final fuel for commodity, housing and stock
markets speculative bubbles.
Bernanke will make more errors in his exit strategy. The Funds Rate should be raised to 3% with
the Discount Rate at 2%, with the use of the Discount Rate a warning that borrowing institutions are
under stress. Monetary Policy needs to flatten the record steep coupon curve and give Americans a
decent rate for increasing savings. That would stimulate consumer spending and help end the
Bernanke has been the worst Fed Chief in my long Wall Street career. Everyone of his text book
ideas have failed in the real world. It was his idea to cut the funds rate to 1% in 2003 as Helicopter Ben.
It was his idea to give the US economy 17 consecutive 25 basis points rate hikes from June 30, 2004
through June 29, 2006, which caused the housing bubble to pop.
US Treasury yields are the benchmark for risk aversion.
The yield on the 2-Year Note has settled in a trading range between 0.6% and 1.2%, and investors
who park money in this maturity are not risk takers. They want Wealth Preservation for the next two
years. A semiannual pivot at 1.089 should keep this range in tact through June.
Chart Courtesy of Thomson / Reuters

The yield on the 5-Year Note rose from 1.5% in March 2009 to 3.0% into June 2009, as money shifted
from longer-term risk aversion to Wealth Creation in the stock market, which gained nearly 40% in that
investment window. The 5-Year yield is now stuck between 2.0% and 2.75%. This range provides risk
aversion for banks who borrow from individuals at 1.5% or less. Banks would rather make a “sure
profit” rather than take the risk of loaning to small businesses at higher interest rates. A flatter yield
curve would end this mismatched arbitrage and perhaps be a catalyst for increased lending.

Chart Courtesy of Thomson / Reuters

The yield on the 10-Year Note rose from 2.5% in March 2009 to 4.0% into June 2009. Now the floor
appears to be 3.1% with my semiannual support at 4.25. My semiannual pivot at 3.675 has become the
benchmark line in the sand between Risk Aversion and Supply / Inflation Concerns. Fortunately for the
housing market standard 30-Year fixed rate mortgages have tightened versus the 10-Year yield, but
tighter lending standards have offset the ability to refinance with the mortgage rate between 4.5% and
5.5% depending upon the lender. Before the rate rise my “Mortgage Mulligan” plan would have given
homeowners a mortgage rate between 3.5% and 4.5%, but now it would be around 4.75%.

Chart Courtesy of Thomson / Reuters

The yield on the 30-Year Bond has been tracking the 200-day simple moving average higher as
investors begin to worry about inflation, which the Federal Reserve is ignoring. The bond yield is
between my semiannual pivots at 4.823 and 4.543. The yield on the 30-Year Bond is an important to
the fair value of every stock. As the bond yield moves higher stocks become less undervalued or more
overvalued, as the yield becomes more competitive to the potential returns from the stock market.
Chart Courtesy of Thomson / Reuters

The Coupon Curve is the spread between the 30-Year Bond and the 2-Year Note, which is now wider
than my semiannual pivot at 345 basis points with quarterly resistance at 413 basis points.
A steepening coupon curve is a characteristic of risk aversion as investors prefer the safety of the lower
yielding shorter maturity US Treasuries.
Banks are making a basic mistake of borrowing short and lending long, as this strategy seems to be the
only risk of profitability they are willing to make. This House of Cards was a factor in the late 1980’s
early 1990’s, as the curve shifted to inversion causing mismatched losses on top of bad loans.
The risk of a flatter yield curve is a factor in Fed policy of keeping the federal funds rate at zero percent
for an “extended period”. The prudent bank should make sure that the maturities of their assets better
match the maturities of liabilities to avoid this eventual shift to a higher rate policy by the Federal
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Richard Suttmeier
Chief Market Strategist
(800) 381-5576
As Chief Market Strategist at ValuEngine Inc, my research is published regularly on the website I
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