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Curve steepening needs more than just BoJ machinations

Publication Date: 26 Jul 2018 - By Marcus Dewsnap By Marcus Dewsnap
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Macro FX & Rates Environmental, Social & Governance Fixed Income/Credit FX USA EU ex-UK China Asia ex-China Other

The last week has witnessed a couple of global curve steepening bouts that have mainly been pinned on talk the Bank of Japa (BoJ) is looking to 'tweak' its yield curve control policy, ergo allow for a steeper Japanese Government Bonds (JGB) curve. US 2-years, 10-years for instance were around 6 basis points (bps) steeper at the peak of the move which began last Friday (20 July).

However, whilst there was a material rise in US 10-years' yield (inflation expectations led the way Friday, real yields Monday), we haven't didn’t see many suggesting steepening as anything more than temporary. Indeed, Informa Global Markets' technical analysis team suggests 37bps as the first crucial resistance for US 2-years,10-years steepening. 34bps has been the widest so far and as of writing, the curve is 30bps.

Still, this is not to say US yields are not rising. One contact pointed to rumours that the White House is looking for close to 5% (annualised) economic growth from Friday's Q2 GDP outturn and recall, President Donald Trump hasn't exactly been shy in broadcasting positive upcoming data!  Meanwhile, 2-year yields hit a fresh cyclical peak of 2.67% late Wednesday although this seems at odds with the view that the Fed is becoming more cautious in raising rates.  

For a curve steepening to become a trend, there needs to be a sustained inflation expectations and real rates rise, a more intense 'risk-on' environment and accelerating rate-hike expectations. On the rates front, inflation expectations and real yields at the longer-end need to rise faster than those at the short-end.

With all this in mind, the BoJ meeting is undoubtedly crucial for any global steepening momentum, given recent gyrations. However, just about any move which is deemed ‘hawkish’, such as raising the 10-year yield target to 0.1% from 0.0%, could induce a ‘risk-off move’.  An added complication for the BoJ is that the volume of quatitative easing (QE) over the years is distorting the JGB and ETF markets (latter maybe also the equity market) and hurting bank profits.

Countering any risk-off feel, though, the Jean-Claude Juncker-Donald Trump trade ‘deal’. If words become action, then the worst of the trade threats may be avoided, and this will be a positive for global economic growth that should support/accelerate inflation expectations and real yields.

As should faster US GDP growth in an economy with little spare capacity. Tariffs operate as a possible constraint on growth (unless one believes the US can truly operate as an autarky) and provide the ‘wrong sort’ of inflation. This aside, the upcoming FOMC is important in the context of aforementioned Fed ‘caution’.

There is an outside chance it may throw some of this caution aside if there is a belief trade issues are less likely to form a significant weight going forward. US forward rates suggests more is required to convince the market flattening is over.

And as of writing, the European Central Bank (ECB) meets. Talk of ‘Operation Twist’ has induce curve flattening in the European Economic and Monetary Union (EMU). If the ECB does downplay this, some steepening may be in play here.

Marcus Dewsnap is Senior Editor/Analyst at Informa Global Markets.

 

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