These Are the Bets on a Steeper U.S. Yield Curve

Investors unwinding wagers on a steepening of the U.S. yield curve will get a chance to rethink their positions this week, with consumer-price data and Treasury auctions providing potential catalysts to shift long-end rates.

Wednesday’s sale of $35 billion in 10-year notes, followed by a $23 billion auction of 30-year bonds the next day, will test the market’s appetite for longer-dated maturities following last month’s lackluster response to 20- and 30-year sales. Moreover, yields on 10- to 30-year Treasuries, recently held in check by tumbling U.S. stocks, could get a lift if Friday’s consumer-prices report comes in stronger than expected on the back of a recovering labor market.

Thursday’s policy decision from the European Central Bank could be another factor that helps determine whether the curve steepens or resumes flattening. Spreads between 2-year and 10-year Treasury yields, along with 5-year and 30-year rates, shrunk every day last week except Friday as buyers unwound bets against long-maturity debt.

Demand for this week’s record-sized auction reopenings “will set the stage for the direction of the Treasury curve in front of the Fed meeting” on Sept. 15-16, said Larry Milstein, senior managing director and head of government debt trading at R.W. Pressprich & Co. in New York.

“A higher CPI means more inflation and higher yields,” Milstein says. What’s more, the curve would steepen “if the ECB surprises with additional stimulus or indicates more could be coming,” which could boost risky assets and support the carry trade at the expense of Treasuries.

The worst week for U.S. equities since June has ramped up demand for haven assets, pressuring the 30-year yield lower over much of last week as steepener trades were pared. The 10-year yield followed a similar pattern.

Steepeners, along with positions favoring inflation-protected securities, have been intrinsic to the bond-market’s bets on reflation. Expectations for annual inflation in the next decade, as reflected in the 10-year U.S. breakeven rate, have jumped to 1.70% from as low as 0.55% in March, while Federal Reserve policy makers officially move toward greater tolerance for price pressures to overshoot.

Although month-over-month inflation readings have been higher than they were from March to May, the year-over-year numbers remain well below the Fed’s 2% target and “higher inflation will not be an issue for the U.S. for the foreseeable future,” said Tony Farren, managing director at broker-dealer Mischler Financial in Stamford, Connecticut. In addition, “the market has had a hard time taking down the Treasury supply on the fly because the auction sizes are so big.”

What to Watch

  • U.S. markets are shut Sept. 7 for Labor Day. Macro highlights in the holiday-shortened week include the European Central Bank’s policy decision on Thursday. Fed officials are in a blackout period ahead of the Sept. 15-16 meeting.
  • Here’s the economic calendar:
    • Sept. 8: NFIB small business optimism; consumer credit
    • Sept. 9: MBA mortgage applications; JOLTS job openings
    • Sept. 10: Producer prices, initial and continuing jobless claims; Bloomberg consumer comfort; wholesale inventories and trade sales
    • Sept. 11: Consumer prices; average hourly and weekly earnings; Bloomberg September U.S. economic survey; monthly budget statement
    • Sept. 8: 13-week, 26-week, 52-week bills; 42-, 119-day cash management bills; 3-year notes
    • Sept. 9: 10-year notes reopening, 30-year bonds reopening

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