Senior Fixed Income Strategist
Summary: Technical analysis shows that there is space for the US yield curve to flatten amid the US election. However, in the long-term, only a steepening is possible with the 30-year Treasury yields leading the way. The Fed will need to decide soon whether expanding its bond purchasing programme over long-term maturities to avoid a fast steepening of the yield curve.
Even though yesterday the market was a red sea with US equity indices falling around 3.5%, the bond market saw US Treasury yields barely moving. The front end of the yield curve 2s10s was stable while the 5s30s steepened slightly by one basis point. The US Treasury yesterday was able to sell $55bn of 5-year government bonds at a yield of 0.33%, which was 0.5% below the market's expectations. Investors' participation in the auction is key to understanding the prevailing sentiment in the bond market. The bid-to-cover ratio was below the 1-year average, and more than 60% of the notes were awarded to indirect bidders. This means that while foreign demand continues to drive US Treasuries performance, domestic government bond demand is slowing down amid the US election and the reflation story.
To understand how US Treasuries will perform going into the US election week, we can analyze the part of the yield curve that is currently being most active: the 5s30s.
This year, the long part of the yield curve is steepening faster compared to what we have seen from the second half of 2018 until the beginning of this year. The 5s30s spread is trading in an ascending wedge which has tested already twice. It would not be surprising to see the spread trying the support line as we get closer to the election. If the support line is broken, we can see the spread finding the first level of support at 109.30.
At present, long term yields are the biggest movers of the US yield curve. Thus, movements in 30-year yields are critical to understanding the yield curve direction.
Below you find a candle chart of the 30-year Treasury yield since the beginning of the year until today. As you can see, the 30-year yield broke above what it used to be its resistance line. The new support line has already been tested twice. As the election approaches and we experience more volatility in the equity market, it will most likely be tested again. If risk-off sentiment pushes yields below the support line, the 30-year yields will find support at 1.42%.
Even though we can see a slight flattening of the yield curve in the short term, in the long-term, some elements point to the fact that only a steepening of the yield curve is possible.
As the graph below shows, sentiment over US Treasuries has deteriorated since the beginning of the year until today. However, Treasury yields didn't rise because of recent risk-off trading dynamics. We expect this to change as reflation becomes a more threatening factor after the US election, especially if Biden wins.
Investors are increasing their short positions in US Treasury futures as reflation becomes a real threat. 30-year Treasuries are falling faster compared to 10-year Treasuries because the Federal Reserve accommodative monetary policies control the front part of the yield curve. Suppose the Fed doesn't want Treasury yields to rising fast after the elections. In that case, it may need to expand its bond purchasing programme to longer-term maturities.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
