Wall Street sees Trea­suries yield curve flat­ten­ing into 2019

Gulf Times Business - - BUSINESS -

This month’s bond-mar­ket slump hasn’t jolted the ma­jor­ity of Wall Street strate­gists from one core view: that the Trea­suries yield curve will keep flat­ten­ing well into next year.

Strate­gists at most of the Fed­eral Re­serve Bank of New York’s pri­mary deal­ers ex­pect the spread be­tween 2and 10-year yields to nar­row through the first half of 2019, ac­cord­ing to yield fore­casts compiled by Bloomberg.

From about 30 ba­sis points now, the av­er­age pre­dic­tion is for the gap to shrink to 21 ba­sis points by year-end, and to about 11 ba­sis points by June. Still, it may be a bumpy ride, with fore­casts for mid-2019 rang­ing from a 30 ba­sis point in­ver­sion to a pos­i­tive slope of a half-point.

The key to the ma­jor­ity view is the ex­pec­ta­tion that the Fed will keep tight­en­ing, while sub­dued growth and con­tained in­fla­tion cap longer-ma­tu­rity yields. Fur­ther flat­ten­ing could make things un­com­fort­able for those lean­ing the other way.

It may also be prob­lem­atic for pol­icy mak­ers be­cause some in­vestors see the march towards in­ver­sion as sig­nal­ing a re­ces­sion.

“The flat­ten­ing con­tin­ues, and it’s re­ally a grind,” said Shahid Ladha, head of Group-of-10 rates strat­egy for the Amer­i­cas at BNP Paribas. “It’s painful for the Fed. It’s also painful for the mar­ket.”

The climb in yields gained mo­men­tum at the start of this month, push­ing the bench­mark 10-year rate to the high­est since 2011 and spark­ing the big­gest jolt of curve steep­en­ing since Fe­bru­ary.

The re­ver­sal led some strate­gists to con­clude that flat­ten­ing had run its course. The curve nar­rowed in Au­gust to lev­els last seen in 2007, which is also the last time it was in­verted.

“The bond mar­ket is send­ing us flash­ing yellow signs, say­ing, ‘Hey, it may not be all roses look­ing ahead,”’ Min­neapo­lis Fed Pres­i­dent Neel Kashkari, who doesn’t vote on mon­e­tary pol­icy this year, said this month.

Twenty of the 23 pri­mary deal­ers con­trib­uted yield fore­casts to the sur­vey. At least five see the curve from 2 to 10 years in­vert­ing by the end of Septem­ber next year, with some say­ing that will hap­pen as early as the first quar­ter.

In the view of Bar­clays Plc, yields at the front end will keep climb­ing while those on the 10-year will stay near 3%. The bank fore­casts an in­ver­sion to mi­nus 10 ba­sis points by the end of March and to mi­nus 25 by the end of the third quar­ter.

“Even though the fis­cal stim­u­lus is lift­ing near-term growth, we don’t think it ma­te­ri­ally changes the out­look over the medium- to long-term,” said An­shul Prad­han, a Bar­clays strate­gist. “Growth is likely to move back down to­ward a sub­dued trend.”

But sev­eral banks dis­agree. Deutsche Bank AG, for ex­am­ple, ex­pects a spread of 50 ba­sis points at mid-year. Jef­feries LLC sees that level by the end of Septem­ber 2019 amid re­duced pen­sion­fund de­mand and Euro­pean Cen­tral Bank ac­com­mo­da­tion, along with in­creased longer-ma­tu­rity is­suance as deficits deepen.

“You are go­ing to get more sources of longer- term sup­ply, just as sources of de­mand will wane,” said Ward McCarthy, chief fi­nan­cial econ­o­mist at Jef­feries.

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