Bitcoin and a Flattening Yield Curve

December 7, 2017

Bitcoin and a Flattening Yield Curve Photo

Bitcoin is a hot topic in the financial media right now. At post time, one bitcoin is worth approximately $11,750, up from roughly $1,000 at the beginning of 2017.

We also see the craze for bitcoin in the stock market. For instance, shares of (OSTK), a small e-commerce company, spiked in price after announcing they have a venture that works on cryptocurrency related applications. Riot Blockchain, Inc. (RIOT), formerly a small biotech company, recently refocused their research from animal fertility to blockchain technology, driving their stock price from $8 per share to $23 per share in a week.

Over the weekend, we heard the news that Bill Miller turned $2 million in bitcoin into $75 million, and the Winklevoss twins became billionaires from their investment in bitcoin.

This all reminds me of the “dot com” era. I will be very cautious with bitcoin at this point. Some believe it can go up another $10,000 to $20,000, but I still believe it is more a game of greater fool than a viable investment.

While bitcoin prices have generally risen each day, the Treasury curve simultaneously flattens. When we look at this week’s chart, the yield spread between two-year and 10-year Treasury is at roughly 56 basis points (bps), the lowest point in the last 10 years.

There are two main drivers for the flattening yield curves:

  1. The U.S. Treasury indicated they will mainly use two-year Treasuries to fund the increasing funding needs next year. This increased supply of front-end Treasuries drove up their yields.
  2. The corporate tax rate will likely come down next year. Because pension contributions are tax deductible, the tax deduction is worth more now than when the tax rate declines. As a result, corporations want to contribute to their pension plan before the end of the year. These contributions into the pension plan are mostly used to purchase long-term bonds to immunize the pension liability. This increased demand for long-term bonds drove down the yield for long-end Treasuries.

The flattening of the yield curve has happened quickly, just like the bitcoin rally. However, while I won’t buy bitcoin, I don’t think the flattening yield curve will fade away.

The front-end rates trade with the Federal Reserve (Fed) rate hike expectation and economic growth in the next 12 to 18 months. At this point, the economy is looking good. With tax reform moving ahead, we are getting a tax cut in a robust economy. There is not much slack in the economy at this point and the Fed will have to hike rates more next year. These factors will likely increase front-end yields. The long-end rates trade with the long-term potential for economic growth and inflation, which hasn’t changed much. When the Fed keeps hiking rates in the next year, the yield curve can stay flat or even inverted after a few more hikes.

Key Takeaway:

The bitcoin rally is unlikely to be sustainable. The flat yield curve is not a sign of recession risk; it is more driven by supply and demand dynamics at the moment. Longer term, the yield curve is likely to stay flat, when we have a positive cyclical outlook with structural headwinds from demographic, technology and financial leverage.


Tags: Chart of the Week | Inflation | Federal Reserve | Yield curve | Economic growth | Bitcoin

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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