Treasury Curve Near Steepest Since 2017 as a 30-year return climbs
(Bloomberg) – U.S. Treasury’s yield curve is approaching its steepest level in three years as political responses to the coronavirus pandemic and glimpses of hope on the economic front push a source between medium and long-term rates.
The spread between 5-year and 30-year yields touched 117.6 basis points on Tuesday as long-term interest rates rose to a two-month high. The curve slope was steeper in just one day this year – March 19 in the teeth of the liquidity crisis, prompting the Federal Reserve to increase its daily government bond purchases. The spread touched 118.2 basis points the day before easing to approx. 80 basis points within days as the Fed floods the market with liquidity.
That resurgence since then reflects Fed policy expectations that keep short-term interest rates low, while the Treasury increases the long-term supply to finance economic recovery conditions, said Guneet Dhingra, head of the U.S. interest rate strategy at Morgan Stanley (NYSE :). The curves are also moving along with a sense that the economy may begin to revive after months of shutdown measures, with stocks hovering close to their peak in almost three months.
“When the news is good, 30-year interest rates tend to go higher a lot more than the front-end because everyone understands that when things improve the Fed, it won’t rush to raise interest rates,” Dhingra said.
But the curve has also gotten stronger on days when interest rates fall, as investors see the potential for the Fed to respond with measures, including a negative key policy rate – which it has hitherto disappeared – and that could lead to lower short-term interest rates.
Declining economic news leads people to “expect the Fed to do more in terms of forward guidance,” and “on the margin, the market believes negative interest rates are starting to become feasible as things worsen”, prompting major declines in 5 years than for 30-year interest rates, Dhingra said.
Long-term maturity rose in May for the first monthly increase this year as the U.S. equities advanced, reflecting improved investor sentiment as stay-at-home orders were rescinded in some states, allowing companies to reopen. Data on continued unemployment claims last week also suggested that the labor market may have begun to rebound. Meanwhile, on the policy front:
- Supply and Demand: The Treasury Department on May 6 set larger than expected auction size for 10-year notes, 30-year debt and the first new 20-year bond in a generation. The shift indicated that it will rely more on the long-term issue to raise nearly $ 3 trillion from April-June to fund economic recovery measures.
- At the same time, the Fed has slowed the pace of buying in stages, most recently to $ 4.5 billion a day this week.
- Monetary Policy Expectations: Investors are betting that the Fed will move to cap Treasury interest rates for the five-year, while keeping its policy rate effective at 0%. This will involve committing to buy as many securities as necessary in that part of the curve to maintain interest rates at a certain level. The Reserve Bank of Australia has already adopted such an approach to yield curve control policy.
“This trade so far has been tactical, but it has the potential to become strategic” in a few months “as improving economic data” begins to put pressure on interest rates to rise higher, “Dhingra said.
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