Global Yield Curves Flatten as BofA Says Wager on More to Come

(Bloomberg) -- Sovereign-bond yield curves around the world flattened this week, resuming a longer-term trend, as Bank of America said it’s skeptical that Federal Reserve policies can further steepen the U.S. curve.

The gap between five- and 30-year yields narrowed for a third day, ending the week flatter along with equivalent gauges in Japan and Germany. Long-term debt outperformed on Thursday after Mario Draghi signaled the European Central Bank won’t stop its bond-buying program without tapering it first.

The flattening comes a week after remarks by Fed Chair Janet Yellen indicating a willingness to let the U.S. economy run hot caused a gauge of the U.S. yield curve to steepen by the most since March. Bank of America says it questions whether the Fed’s intent to raise interest rates gradually can produce the sort of high-pressure economy that would accelerate inflation and further elevate longer-term yields.

“We are highly skeptical of the ability for monetary policy to deliver a steepener in U.S. rates from this level,” Bank of America Merrill Lynch strategists led by Shyam Rajan wrote in note Thursday. "We would recommend outright and conditional bear flatteners to go against the consensus view of steeper U.S. rates curve on the back of optimal control or fiscal stimulus."

U.S. 30-year bond yields fell two basis points, or 0.02 percentage point, to 2.48 percent at 5 p.m. in New York, according to Bloomberg Bond Trader data. The price of the 2.25 percent security due in August 2046 rose to 95 2/32.

The gap between yields on five- and 30-year notes, a gauge of the yield curve, flattened to about 1.24 percentage points, the lowest closing level in more than a week.

Inflation Expectations

Long-term bonds are typically more sensitive to the outlook for economic growth and inflation, while short-dated notes tend to more closely track expectations for central-bank monetary policy.

The 10-year break-even rate, a gauge of inflation expectations that measures the difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, fell for a second day to about 1.68 percentage points, after closing on Oct. 14 at the highest level since April.

“All central banks have focused on trying to do their best to increase inflation expectations," said Subadra Rajappa, head of U.S. rates strategy in New York at Societe Generale SA, one of 23 primary dealers that trade with the Fed. "Accommodative monetary policy as well as a willingness to let inflation run could be a strategy that central bankers can use to show their commitment.”

Traders this month have added to wagers that the Fed will deem economic growth sufficient to raise interest rates by year-end. Fed fund futures indicate the probability of an increase by the December policy meeting is about 68 percent, up from 59 percent at the end of September. The calculations assume that the effective fed funds rate will average 0.625 percent after the next increase.

Bloomberg
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