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Goldman Sachs Has a Twist on the U.S.’s Favorite Bond Trade

Record Shorts Show New Bets on Steeper Treasury Yield Curve

Goldman Sachs Group Inc. is shaking up the most popular Treasury trade out there.

The Wall Street giant recommended in an Oct. 2 note that investors short 10-year U.S. bonds versus their two- and 30-year counterparts, a position that will benefit if 10-year yields rise more than the other two tenors. Traders have been piling into straightforward bets on steepening, a scenario that has received additional support as polls and betting websites indicate former Vice President Joe Biden’s odds of beating President Donald Trump are improving, burnishing the outlook for more stimulus.

Goldman was fleshing out a bearish bond view published last month, and comes as long trades on 10-year Treasury futures rose to the highest since October 2017, according to the latest Commodity Futures Trading Commission data. Net short speculative positions on bond futures further out the curve climbed the most since 2007 last week to around 209,000 contracts, an all-time high.

Meanwhile, the spread between 10- and 30-year Treasuries is testing its widest level this year, led by a sell-off in the longer-end of the curve.

But Goldman says that if the Democrats sweep the U.S. elections, 10-year bonds will suffer most, with yields rising by 30 to 40 basis points in the month following the outcome. JPMorgan Chase & Co. also warned that steepening trades could unwind, citing stretched positioning.

Goldman Sachs Has a Twist on the U.S.’s Favorite Bond Trade

“In a Democratic sweep scenario, markets could start to contemplate earlier liftoff, which would disproportionately affect this portion of the curve,” Goldman strategists led by Praveen Korapaty wrote, referring to the timing of possible of interest-rate hikes.

So-called steepener trades are often seen as bets on a pickup in inflation. They’ve become popular as investors brace for greater deficits should the Democratic party prevail in November’s election. A Wall Street Journal/NBC News poll taken after last week’s debate showed Biden leading Trump by 14 percentage points. It was taken before the president was diagnosed with coronavirus.

The spread between 10-year and 30-year yields has widened by more than 30 basis points this year and was around 80 basis points on Monday, about three basis points shy of this year’s intraday high set in March.

The gap between the five- and 30-year yields also expanded Monday, reaching 124 basis points, its widest since Sept. 1.

Similar bets are also being made in the swaption market. Options on swap rates show the cost to hedge against a 25-basis-point rise in 30-year rates is at the highest in six months relative to protection against a decline of the same size.

Meanwhile, the front-end of the curve has been anchored by bets that the Federal Reserve will keep interest rates near 0% for at least three years. That’s helped widen the gap between two-year and 10-year Treasury yields to 58 basis points this year to the highest level in a month.

For JPMorgan strategists including Jay Barry, the surge in Treasury shorts appears to be related to new wagers on the direction of the curve, rather than so-called basis trades that bet on the spread between bonds and futures.

“We think curve positioning could be behind those moves,” they wrote in a note to clients Friday. “While outright exposure to duration positions are not large, curve steepening positions remain large relative to historic ranges, and the risk is these trades could be unwound.”

©2020 Bloomberg L.P.