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Bull steepeners find fertile soil in the summer break

Picture of Althea Spinozzi
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Curve steepeners might have further room to run in the next few weeks. The front part of the yield curve will remain underpinned by the speculation that the Federal Reserve and the ECB are close to ending the hiking cycle and inflation is adjusting lower. At the same time, long-term yields can increase as investors weigh in on the BOJ yield curve control tweak.

Yet, things might change between September and October, as markets understand that the Fed is not done, that it is just slowing down the pace of interest rate hikes, and that the peak benchmark rate might be higher than previously forecasted. That might revive a selloff in the front part of the US yield curve.

In Europe, weak economic data and falling inflation might completely wipe out bets for another interest rate hike.

Bond futures might be mispricing future rate hikes: the ECB is closer to being done hiking than the Federal Reserve.

Following this week’s monetary policy meetings, markets are convinced that in Europe and the United States, the end of the rate hiking cycle is near. The ECB and the Fed hiked interest rates by 25bps but kept a flexible approach to future rate decisions. That provoked a bull steepening of their sovereign yield curves as the market is positioning for the end of the hiking cycle on both sides of the Atlantic.

Yet, robust US economic data and weak European data are putting light on the contraction of monetary policies' expectations.

Bond futures show the possibility of a 9bps rate hike in the US by November, while they show almost a 20bps rate hike in Europe by December. Yet, macroeconomic data tell us that the ECB might be closer to ending the hiking cycle than the Fed. Therefore, while today's PCE data might further erase Fed rate hike expectations as the monthly core PCE is expected to come at 0.2%, two more CPI and job reports before the September Fed meeting might revive the expectation of another rate hike. It's important not to forget that, according to economist forecasts, the US core PCE is expected to close the year at 4.2% and to decrease to 2.7% in 2024 and 2.2%, staying well above the Fed's inflation target. Depending on the economy's resilience and the job market, that might warrant more rate hikes. Thus, the Fed's peak rate might be as high as 6%, but the Fed will arrive there slower and keep rates higher for longer, hoping for inflation to continue to drop.

Things in Europe are slightly different. The biggest euro economy is in a recession, and the economy is expected to remain weak with contracting industrial orders, soft purchasing power, and a slowdown in credit facilitation. That means that deflation might be faster in the Eurozone and that although we believe that another rate hike is warranted, the ECB might end the hiking rate cycle before the Fed.

Long-term EU and US sovereigns are at risk amid a more flexible Bank of Japan.

The Bank of Japan tweaked its yield curve control policy, allowing 10Y JGB to trade within a band of +/- 1%. For more information click here.

It is not a coincidence that the policy changed now that the market believes that we are at the end of the hiking cycle in the US and Europe because it puts less selling pressure on JGBs. Although Ueda assured he doesn't expect 10-year JGB yields to soar to 1%, we believe that traders will be inclined to test the limit imposed, giving ample room for Japanese investors to buy JGBs at the highest level since 2012.

The problem is that Japanese investors forced to buy higher-yielding securities abroad for many years, are now finding JGBs much more convenient than US and German Bunds for the first time since 2007. Therefore, a great Japanese repatriation might begin pushing European and US Treasury yields higher.


We are now seeing 10-year US Treasury yields test resistance at 4%. Given today’s BOJ yield curve control tweak and the country’s macroeconomic resiliency, 10-year yields may move to test resistance at their 2022 high of 4.31%.

Source: Bloomberg.

Ten-year German Bund yields remain in an uptrend, on their way to their February peak at 2.76%. To contain their rise is the scarcity of collateral in the euro area and the dire economic data.

Source: Bloomberg.


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