The Bond Market Is Flashing a Signal That Traders Haven’t Seen Since 2012

Deutsche Bank's Chadha: 'Serious Carnage' Coming in Bonds
  • Yield curve steepens as traders trim bets on higher Fed rates
  • Bonds trail on dimmed speculation central banks to keep buying

The $13.6 trillion Treasury market is sending a signal it hasn’t flashed in more than four years.

The message: Shorter-dated debt is the place to be as traders gain confidence the Federal Reserve will keep interest rates on hold, at least through next week’s policy meeting. The extra yield investors demand to own 30-year rather than five-year securities, a measure of the yield curve, increased for a ninth straight day Wednesday. That’s the longest streak since 2012, data compiled by Bloomberg show.

Traders are favoring shorter maturities as a Fed on hold is seen as potentially stoking inflation, which erodes the value of debt maturing decades in the future. There’s another reason those maturities are lagging behind: international central banks are showing reluctance to extend the expansionary monetary policies that drove yields in Europe and Asia to record lows and stoked demand for long bonds in the U.S., too.

“More than rates, the curve shape has been consistent, and telling a strong story,” said Aaron Kohli, a fixed-income strategist in New York at BMO Capital Markets Corp., one of the 23 primary dealers that trade with the Fed. "Everyone thinks the Fed will be on hold forever."

The yield on benchmark U.S. 10-year notes were little changed at 1.71 percent as of 6:51 a.m. in London on Thursday, based on data compiled by Bloomberg. The price of the 1.5 percent security due in August 2026 was 98 3/32.

September Revival

The spread between five- and 30-year yields is rebounding after contracting in August to the narrowest since the first quarter of 2015. It was at 124 basis points, up from as little as 102 basis points last month.

The last time the yield curve steepened this quickly, in August 2012, primary dealers were offloading billions in 30-year bonds to the Fed as part of its debt-buying program.

Futures signal around a one-in-five chance that the policy makers will raise rates when they meet on Sept. 20-21, amid tepid economic growth and restrained inflation. Fed Governor Lael Brainard, who spoke Sept. 12 in the central bank’s final scheduled comments before the gathering, said prudence is warranted in the Fed’s rate path as boosting borrowing costs poses risks.

Thirty-year Treasuries had their biggest two-day selloff in more than a year last week after European Central Bank President Mario Draghi disappointed investors who were anticipating an extension to the institution’s bond-purchase plan. In July, Bank of Japan Governor Haruhiko Kuroda opted against expanding the nation’s unprecedented easy money policies.

“Central banks are taking a step back on stimulus, and the U.S. is definitely being affected by it,” said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald LP, another primary dealer.

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