Yield Curve & SIV shocks

Credit crisis in the US with rising home foreclosures and defaults is causing a steepening of the yield curve. Such news though very important doesn't get much media attention. Here is an article from Bloomberg that captures the current scenario well. Excerpts follow:

Anxiety over the $300 billion owed by structured investment vehicles, or SIVs, is pushing investors into the relative safety of two-year notes sold by the government and the most creditworthy companies at the same time that rising consumer prices reduce the appeal of 10-year securities. The gap in yields between the bonds is getting wider, reminiscent of 2001, when the Federal Reserve began cutting its target interest rate for overnight loans between banks.
``Across 2008, sustained steepening of the yield curve will be a consistent theme,'' said Ajay Rajadhyaksha, head of fixed- income strategy in New York at Barclays, one of the 21 primary government securities dealers.
Investors seeking safety piled into short-term securities last week after Rhinebridge Plc, the SIV run by Dusseldorf, Germany-based IKB Deutsche Industriebank AG, said it may not be able to repay all its debt, and receivers said a fund run by London-based Cheyne Capital Management Ltd. will stop paying creditors. SIVs borrow in short-term debt markets to finance purchases of longer-maturity assets.

Tumbling Yields
The yield on the benchmark two-year note tumbled the most since September 2001 last week, by 45 basis points to 3.78 percent. The 10-year yield dropped 29 basis points to 4.39 percent.

Derivatives
Mortgages entering foreclosure increased to 0.65 percent in the second quarter, the highest recorded in the 35 years the Mortgage Bankers Association in Washington has tracked the data. U.S. builders broke ground at an annual rate of 1.191 million homes in September, the lowest in 14 years, the Commerce Department said last week. The same day, the government said consumer prices rose 2.8 percent last month from a year earlier, matching the biggest increase of 2007.

Nowhere is the outlook for a steeper yield curve more evident than in the derivatives market.

Inverted Curve

Longer-maturity debt typically yields more than shorter- dated securities because investors demand a bigger premium to lend for a longer period. Ten-year yields have exceeded two-year yields 80 percent of the time over the past decade, Bloomberg data show.

Between June 2006 and May 2007, the curve was inverted 82 percent of the time after the Fed lifted rates at 17 straight meetings in two years.

Investors watch the relationship between short- and long- term yields because the economy has gone into recession six of the seven times since 1960 that the relationship inverted.

Measures of investor attitudes about the outlook for credit suggest that demand for the safest of government debt will continue.