US Treasury 5s30s and 10s30s Curve - Flat Curve Predictions?
The current trajectory of the flattening in the US Treasury 5s30s curve (30y yield minus 5y yield) and the 10s30s curve (30y yield minus 10y yield) illustrates a potential for the following:
1) A flat curve by July 2018 if the flattening trajectory continues (green lines);
2)A flat curve by Nov 2018 if we plot the trajectory from the recent steepening of the curve (red lines).
1) A flat curve by July 2018 if the flattening trajectory continues (green lines);
2)A flat curve by Nov 2018 if we plot the trajectory from the recent steepening of the curve (red lines).
Bình luận:
I think its appropriate to provide an update on this as I believe the conditions for a 5s30s US curve steepener are ripe. Even if the FED hikes 3 more times in 2019, this might mean another 23bp of flattening to near the 2006/2007 flattest levels. It also means putting on a flattener at these levels (around 23bp) becomes harder as this is a negative carry trade (you are selling approx 6x more 5y bonds vs buying 30y bonds in such a duration-neutral flattener trade).
However, I now like the 5s30s steepener at these levels as a downside hedge to the US economy and political risk. If the FED were to stop, pause or if the mid-terms created chaos this curve has enough room to steepen at least to near 70bps (the 61.8% fib level going back 10 years) - i.e. an approx 50bp upside - also a 5s30s steepener is a positive carry trade (roughly 8bp of carry over a 6 month time horizon).
The biggest demand/supply argument for the steepener also comes from the fact that the US may be looking at long-bond issuance to fund their ever increasing deficit (I think the front end has seen way too much supply and has been absorbed by pensions, money managers etc.). The question is whether this supply is absorbed well enough by the market (pension/LDI demand) or not.
The macro argument for the steepener trade also speaks loudly to me - for 10 years central banks have kept yields extra low meaning government bonds are some of the most overvalued assets. With the FED decreasing its balance sheet size and more central banks looking at removing/reducing QE, there is enough reason to tell me that the market will likely reprice yields higher than their current artificially low levels - 30y yields would be move up the highest in such a scenario and fast...again more ammo for me to justify a view favouring a 5s30s steepener.
The risk reward therefore in my humble opinion is for the curve to begin steepening.
However, I now like the 5s30s steepener at these levels as a downside hedge to the US economy and political risk. If the FED were to stop, pause or if the mid-terms created chaos this curve has enough room to steepen at least to near 70bps (the 61.8% fib level going back 10 years) - i.e. an approx 50bp upside - also a 5s30s steepener is a positive carry trade (roughly 8bp of carry over a 6 month time horizon).
The biggest demand/supply argument for the steepener also comes from the fact that the US may be looking at long-bond issuance to fund their ever increasing deficit (I think the front end has seen way too much supply and has been absorbed by pensions, money managers etc.). The question is whether this supply is absorbed well enough by the market (pension/LDI demand) or not.
The macro argument for the steepener trade also speaks loudly to me - for 10 years central banks have kept yields extra low meaning government bonds are some of the most overvalued assets. With the FED decreasing its balance sheet size and more central banks looking at removing/reducing QE, there is enough reason to tell me that the market will likely reprice yields higher than their current artificially low levels - 30y yields would be move up the highest in such a scenario and fast...again more ammo for me to justify a view favouring a 5s30s steepener.
The risk reward therefore in my humble opinion is for the curve to begin steepening.
Also, Libor-OIS is still wide. One can argue Libor-OIS is structural in nature largely due to repatriation, BEAT tax and Tbill supply which can be attributed to Q1 and maybe Q2. Hence markets haven't really reacted and while L-OIS has gone wider, XCCY basis have tightened (JPYUSD, EURUSD and CADUSD).
If however, Libor-OIS continues to stay wide after Q2 then I predict the market will likely begin to see problems as the cost of funding trillions of dollars of products tied to Libor goes higher - a shift from a structurally driven increase in Libor-OIS to a credit/liquidity driven problem, the latter is going to be a big problem...