Photographer: Andrew Harrer/Bloomberg
Yield-Curve Flattening Gets New Life After Inflation Fears SubsideBy
CPI data meet expectations, show weakness under the surface
Strong 30-year bond auction drives curve to flattest in weeks
Two big events for traders in the $14.7 trillion Treasuries market just sent clear signals that a flatter yield curve could be back in vogue.
The yield spread between 5- and 30-year Treasuries touched the lowest since Feb. 2 on Tuesday after the latest consumer price data came in as expected, with the core measure remaining below 2 percent. What’s more, weak elements of the report suggest the prospect of softening inflation may be a bigger concern than fears of an acceleration.
Market gauges of inflation expectations fell on the data, giving investors confidence at Treasury’s auction of 30-year bonds, which drew a lower-than-expected yield. And unlike recent U.S. debt sales, it was deemed “strong” by Wall Street strategists. Longer maturities extended a rally while shorter tenors were little changed.
By just about every measure, the U.S. yield curve reached the flattest levels in a decade earlier this year as traders wagered the Federal Reserve would stick to its path of raising short-term rates, while subdued inflation kept longer-term yields in check. Strong wage growth and inflation numbers released last month interrupted that trend. That skittishness has now evaporated, at least for the moment.
“The strength of the 30-year auction despite a persistent rally speaks to the depth of demand for the long-bond and reinforces our own conviction that the 5s/30s curve will continue to flatten,” BMO Capital Markets strategist Aaron Kohli wrote in a note.
With the week’s U.S. debt sales out of the way, the bond market’s focus will likely turn to the Fed’s policy meeting next week, which will include a press conference and updated projections, known as the “dot plot.” It’s widely expected that officials will raise the benchmark lending rate -- the bigger question is how the dots move, if at all, given labor-market strength.
That attention to the Fed’s rate-hike path will probably send five-year yields even higher in the days ahead, Kohli said. As of last week, hedge funds and other large speculators were positioned for that kind of move, with futures data showing record net shorts in the maturity.
The 30-year Treasury yielded 3.1 percent at about 3:30 p.m. in New York, lower than the auction’s 3.109 percent mark. The benchmark 10-year yield is about 2.84 percent, nearly unchanged over the past month. Both touched session lows in a knee-jerk reaction to President Donald Trump ousting Secretary of State Rex Tillerson, a move that also flattened the curve.
Combine that with what Kohli called the best auction of the week, and traders saw a green light to further flattening.
“Immediately after the auction, the five-year sector sold off a little bit, so it looks like bidders took advantage of the liquidity opportunity to put on more flatteners,” Thomas Simons, a money-market economist at Jefferies, said in a note. “This auction went well in spite of the $1 billion increase in size for auctions this quarter and the rally in the market throughout the day.”