Time to steepen?

Published: Tue 14 March 2023
Updated: Tue 14 March 2023
By steve

In Markets.

Is this the time for a steepener?

The markets have had a wake-up call with demise of Silicon Valley Bank (and Signature Bank, although that’s more of a crypto side show). For the last year or so we’ve seen the most vicious inversion of US yields on record, as the market discounted an endlessly tightening by the Fed (increase in short-term yields) and a steadier yield at the long end (reflecting an expectation that eventually the Fed’s medicine was going to start working).

tradingview US10Y-US02Y

The market’s reaction to the collapse of a couple of banks is an assumption, cet. par. that the Fed will now go easy on its tightening, as market panic starts to do it work. Equity valuations going down represents a tightening of financial conditions, as many companies like to avoid cutting their cash dividends.

Is this really the end of progressive inversion? I somehow doubt it, but maybe it’s the start of a normalization of interest rates. In a world where many of the drivers of collapsing inflation have fizzled out, we must surely expect longer-dated rates to rise above short term ones. China now has an aging and shrinking population, and is barely running a trade surplus. The investment needed to ‘decarbonize’ the world economy is going to consume huge quantities of all sorts of commodities. The USA will need some inflation to deliver fiscal drag/bracket creep to push up taxes and push down the net present value of future pension and other liabilities.

I know I’ve said all that before, and maybe yesterday and today represents another false dawn, but at some point the chart above is going to turn, and you should at least do some research into how to put on a TUT spread (or TUT, or TAF, or FYT, or FOB or NOB, or BOB — see this CME page). If you don’t fancy treasury futures, you can do the same via Eurodollar futures, the biggest, deepest, most liquid market of all. NOT TRADING ADVICE, obviously!

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