Yield curve back in spotlight after Treasuries stage rally
Yield curve back in spotlight after Treasuries stage rally
By Jennifer Hughes in New York and Joanna Chung in London
Published: July 1 2006 03:00 | Last updated: July 1 2006 03:00
Copyright The Financial Times Limited 2006
Treasuries rallied and yields fell this week after traders judged that tweaks to the language of the Federal Reserve's statement showed the central bank was softening its line on future interest rate rises.
Before the meeting, investors had priced in an almost 90 per cent probability that this week's quarter-point tightening to 5.25 per cent would be followed by another at its next meeting in August. By yesterday, that had slipped to about 64 per cent.
Yesterday, bonds were heartened that the core personal consumption expenditure price index had held steady at 2.1 per cent in May.
The Fed tracks the inflation measure carefully, and investors were relieved that it had not risen further.
The biggest reaction to the Fed's news was concentrated in shorter-dated notes, "uninverting" the yield curve by leaving 10-year yields above two-year levels for the first time in three weeks. Curve inversions are unusual, since longer-term borrowing carries greater risks and should yield more, and significant or sustained inversions are often followed by economic slowdowns.
From two-year notes yielding 5.270 per cent and 10-years at 5.231 per cent on Monday, the two were level-pegging at 5.175 per cent each yesterday, off early Thursday peaks of 5.292 per cent for twos and 5.255 per cent for 10-year paper.
The shift in the shape of the curve left strategists discussing the potential for "curve-steepening" trades. Analysts at BNP Paribaspredicted a "significant" steepening.
"The two- to 10-year spread is ready to move, and we have an initial target of +5bp, with potential back to the +15 or 20bp area on a one- to two-month view," said strategists in a note.
They think gains for two-year notes would be constrained by the Fed funds rate at 5.25 per cent, since shorter-dated notes track the Fed's targets more closely.
"Consequently, a steepening of the magnitude we envisage would involve a decent sell-off at the long end of the yield curve."
Market watchers at 4Cast, the consultancy, were more wary on the potential for a strong steepening move, attributing much of the recent "uninverting" to the unwinding of previous flattening trades.
*As the first half of the year drew to a close, government bond investors were left nursing negative returns as prices fell and yields tracked interest rate expectations.
Yields on 10-year Treasuries have risen more than 80bp since January, while the 10-year Bund yield added about 76bp to 4.062 per cent and the 10-year UK gilt yield rose more than 60bp to 4.704 per cent. Ten-year Japanese government bond yields were up over 46bp at 1.925 per cent yesterday.
This means 10-year Treasuries and bunds posted negative returns - of about 4.3 per cent each. However, the 10-year gilt and the 10-year JGB fared badly, too, returning -2.56 per cent and -2.90 per cent respectively.
By Jennifer Hughes in New York and Joanna Chung in London
Published: July 1 2006 03:00 | Last updated: July 1 2006 03:00
Copyright The Financial Times Limited 2006
Treasuries rallied and yields fell this week after traders judged that tweaks to the language of the Federal Reserve's statement showed the central bank was softening its line on future interest rate rises.
Before the meeting, investors had priced in an almost 90 per cent probability that this week's quarter-point tightening to 5.25 per cent would be followed by another at its next meeting in August. By yesterday, that had slipped to about 64 per cent.
Yesterday, bonds were heartened that the core personal consumption expenditure price index had held steady at 2.1 per cent in May.
The Fed tracks the inflation measure carefully, and investors were relieved that it had not risen further.
The biggest reaction to the Fed's news was concentrated in shorter-dated notes, "uninverting" the yield curve by leaving 10-year yields above two-year levels for the first time in three weeks. Curve inversions are unusual, since longer-term borrowing carries greater risks and should yield more, and significant or sustained inversions are often followed by economic slowdowns.
From two-year notes yielding 5.270 per cent and 10-years at 5.231 per cent on Monday, the two were level-pegging at 5.175 per cent each yesterday, off early Thursday peaks of 5.292 per cent for twos and 5.255 per cent for 10-year paper.
The shift in the shape of the curve left strategists discussing the potential for "curve-steepening" trades. Analysts at BNP Paribaspredicted a "significant" steepening.
"The two- to 10-year spread is ready to move, and we have an initial target of +5bp, with potential back to the +15 or 20bp area on a one- to two-month view," said strategists in a note.
They think gains for two-year notes would be constrained by the Fed funds rate at 5.25 per cent, since shorter-dated notes track the Fed's targets more closely.
"Consequently, a steepening of the magnitude we envisage would involve a decent sell-off at the long end of the yield curve."
Market watchers at 4Cast, the consultancy, were more wary on the potential for a strong steepening move, attributing much of the recent "uninverting" to the unwinding of previous flattening trades.
*As the first half of the year drew to a close, government bond investors were left nursing negative returns as prices fell and yields tracked interest rate expectations.
Yields on 10-year Treasuries have risen more than 80bp since January, while the 10-year Bund yield added about 76bp to 4.062 per cent and the 10-year UK gilt yield rose more than 60bp to 4.704 per cent. Ten-year Japanese government bond yields were up over 46bp at 1.925 per cent yesterday.
This means 10-year Treasuries and bunds posted negative returns - of about 4.3 per cent each. However, the 10-year gilt and the 10-year JGB fared badly, too, returning -2.56 per cent and -2.90 per cent respectively.
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