Summer will bring deeper yield curve inversions on both sides of the Atlantic Summer will bring deeper yield curve inversions on both sides of the Atlantic Summer will bring deeper yield curve inversions on both sides of the Atlantic

Summer will bring deeper yield curve inversions on both sides of the Atlantic

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  From today, the US yield curve is the most inverted since 1981 as front-term yields outpace the rise of long-term yields. The bond market is pushing interest rate cuts further down the line while pricing higher chances for a rate hike this month. Yield curves on both sides of the Atlantic are poised to further bear-flatten this summer as front-term yields need to catch up with their swaps. Although that might provide better entry points, the front part of the yield curve already provides enticing returns for buy-to-hold-investors seeking to create a bond ladder. Yet, investors should be wary about adding duration risk to their portfolio as long-term yields remain in an uptrend amid a resilient economy. Opportunities for a barbell might open at the end of summer.


With the Independence Day holiday at the doors, markets will have reduced flows today and tomorrow. However, starting from Wednesday, liquidity will return to the US with the release of the FOMC minutes. Jobs data on Friday are critical ahead of the July Federal Reserve meeting, although we don't expect a slightly weaker reading to stop Powell from hiking again. Yet, a surprise on either side might move bond futures, which are now taking another rate hike for granted but struggling to price a second one.

We expect the yield curve to continue to bear-flatten throughout summer, led by the rise of front-term yields.

Today, the spread between 10-year and 2-year US Treasuries broke below March lows, falling to -110 basis points in the morning for the first time since 1981.

The US yield curve will continue to invert for a straightforward reason: short-term yields will likely surge to catch up with the DOT plot and as markets push further down the line expectations of a rate cut.

Long-term yields still have room to move slowly upward if the economy remains resilient; otherwise, they will drop if a recession is forecasted. Either way, the yield curve is meant to flatten, and it could continue to invert to test the 1981 low of -154bps.

Source: Bloomberg,

Ten-year yields are likely to rise to test 4% as inflation and activity data remain resilient. Last week’s core PCE index came at 4.9%, well above the Federal Reserve target, while the Consumer confidence number for June came at 109.7 versus a neutral 100. Tha puts upwards pressure for yields across the yield curve, particularly on short-term yields.

Source: Bloomberg.

The yield curve flattening trend is poised to accelerate in Europe

The inversion trend might accelerate in the old continent during summer as swap spreads in Germany and in the UK remain well above the US one, indicating that two year Gilts and Schatz are trading rich on the curve, and in relationship to their swaps.

Source: Bloomberg.

What does that mean?

  • It means that bonds with short-term maturities might cheapen further. Therefore, a better entry point might present itself in the next few weeks. However, we believe that already now the front part of the yield curve offers enticing returns for buy-to-hold-investors, which are seeking to create a bond ladder.  
  • Investors should be wary about adding onto duration risk. Long-term bonds’ market value suffers from larger moves as interest rates change. Thus, as long-term yields remain in an uptrend due to a resilient economy, it might not be prudent to add on duration risk yet.
  • It might soon shape the perfect environment for a barbell, which will allow investors to take advantage of high interest rates in the short part of the yield curve, while benefitting from long-term bonds’ convexity.

Please refer to this link to find short-term instruments and ETFs.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)


Boulevard Plaza, Tower 1, 30th floor, office 3002
Downtown, P.O. Box 33641 Dubai, UAE

Contact Saxo

Select region

UAE
UAE

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.