Central Banks Add to the Case for Steeper Treasuries Yield Curve

  • Foreign banks’ Treasuries holdings reach highest since 2015
  • Buying usually concentrated in short end, Credit Agricole says

Central banks around the globe are stocking up on Treasuries again, giving bond traders one more reason to wager on a steeper U.S. yield curve in the months ahead.

The amount of Treasuries owned by foreign central banks and held in custody at the Federal Reserve Bank of New York topped $3 trillion last week, the highest level since December 2015. The Fed’s data don’t reveal who’s been buying, but some of the biggest holders, most notably Japan and China, have increased ownership this year, Treasury Department data show.

The influx of money from foreign central banks matters to traders in the $14 trillion Treasuries market because their holdings tend to concentrate in shorter-term U.S. debt, according to Alex Li, head of U.S. rates strategy at Credit Agricole. As long as their demand is strengthening, it should anchor short-end rates at a time when strategists are growing more convinced that the Fed’s plan to trim its balance sheet will cause the yield curve to steepen.

“We have recommended yield curve steepeners to our investor base,” Li said in a telephone interview. “The Fed’s policy normalization would raise term premia,” which in turn tends to widen the spread between short- and long-term interest rates, he said.

After years of unprecedented bond buying following the financial crisis depressed a measure known as the term premium, investors are betting that it’ll rise as the Fed begins unwinding its $4.5 trillion balance sheet. At minus 0.2 percentage point, it’s below the 10-year average of 0.98 percentage point, signaling little concern in the market that yields will move much higher.

While it’s unclear which maturities the Treasury will boost to offset the Fed’s tapering, signs of increased sales across coupon-bearing Treasuries would steepen the yield curve, some analysts say.

Citigroup Inc. U.S. rates strategist Jabaz Mathai also expects the Treasury yield curve from five to 30 years to steepen into the end of the year, given the prospect of the term premium turning positive. That segment of the curve touched 0.92 percentage point earlier this month, the lowest level since December 2007. It’s since rebounded to 1.06 percentage points.

A steepening curve would mean the shorter-term maturities preferred by foreign central banks are outperforming, which could give them an incentive to own more. They’re approaching uncharted territory: the record high came in July 2015, at $3.035 trillion.

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