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Bond Watchers Call for Steeper Curves on Both Sides of Atlantic

Bond Steepener Bets Cross the Atlantic on Europe Inflation Risk

One of the most popular U.S. bond trades is fast becoming a global phenomenon.

At least five banks have piled into recommendations to bet on an increase in the yield premium that longer-dated European debt offers over shorter-term notes. This so-called yield-curve steepening trade mirrors similar calls by some observers of the U.S. market and is largely a reflection of growing inflation concerns and record government borrowing.

In the U.S., Federal Reserve Chair Jerome Powell appeared to give the green light for such trades last week, by signaling the central bank would tolerate an overshoot of its 2% inflation target for a time.

The spread between 5- and 30-year Treasury yields has risen in the past week to levels last seen in early June. A similar gap for Germany has also increased and remained relatively well supported even after euro-area inflation data came in weaker than expected on Tuesday.

Bond Watchers Call for Steeper Curves on Both Sides of Atlantic

“When we’re down and troubled, steeper curves offer a ray of hope,” ING Groep NV strategists led by Padhraic Garvey wrote in a note to clients. “They by definition discount better times ahead. There has been steepening recently, and we think more is coming.”

Global markets have been beset by fears that inflation could roar back thanks to unprecedented stimulus from governments and central banks as they attempt to stem the economic fallout from the coronavirus pandemic. Rising prices erode the value of holding bonds, especially longer-dated securities, meaning that those are more likely to fall than shorter-dated notes.

Mark Kiesel, co-manager of Pacific Investment Management Co.’s flagship Total Return Fund, is among those in the U.S. who stuck to positions for a steeper curve slope even as it went downhill in June and July.

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In Europe, the likes of Barclays Plc and UBS Group AG recommend that investors position for higher long-dated rates via trades that anticipate a steeper interest-rate swap curve. For Citigroup Inc., the transaction also acts as a hedge for any breakthrough on a vaccine for the coronavirus, which would likely spark a selloff in the bond market.

What Bloomberg Intelligence says:

“The curve may steepen on post-summer increase in supply and catch-up to higher inflation pricing. But don’t expect any tantrum, any repricing is looking modest at best.”

-- Tanvir Sandhu, Chief Global Derivatives Strategist

The U.K.’s case isn’t different either, with Goldman Sachs Group Inc. recommending positioning for the yield premium on 30-year bonds over two-year ones to increase. The bank sees the Bank of England potentially changing the sequencing of any tightening of monetary policy, allowing quantitative easing to run off before interest rates are raised significantly.

For Societe Generale SA, the steepener trade should benefit from investors abandoning their summer caution as well as progress on the European Union’s landmark recovery fund, which has buoyed sentiment across the region. Bond supply too is set to pick up into year-end.

“Summer jitters did not materialize,” wrote SocGen strategists led by Adam Kurpiel. “New issuance is the key focus now.”

©2020 Bloomberg L.P.