Make-or-Break Time Coming for Fans of Treasury Curve Steepener

(Bloomberg) -- In ordinary times, this would be a dangerous week for fans of long-dated Treasuries, but these are far from ordinary times.

A stronger-than-expected U.S. jobs report on Friday opened a path for longer-maturity yields to climb and the curve to steepen. This week’s historically large Treasury auctions could help, along with the prospect of another stimulus package and a possible pickup in inflation data. Rates probably won’t get far, though. It hasn’t paid to bet against investor appetite for Treasuries in the midst of a global health crisis.

The pandemic’s resurgence has reshaped the Treasury curve, crushing the steepener trades that flourished between April and June on hopes that the American economy would reopen smoothly. The 2- to 10-year curve has slumped to just 43 basis points from 72 on June 5. Last week, it barely twitched when the Treasury’s estimates of its borrowing needs for the rest of the year blew through Wall Street expectations, to more than $2 trillion.

“Those trades, they’re just not working right now, in an environment where they should be if you add up everything that’s going on,” said Tim Magnusson, a portfolio manager at Garda Capital Partners LP.

Several forces are weighing on the curve, not the least of which are heavy misgivings about the U.S. recovery. Even the surprising addition of 1.76 million jobs last month, according to the latest payrolls figures, pushed the benchmark 10-year yield only a couple of basis points higher Friday, to 0.56%. That’s still within 25 basis points of its record low from March.

Moreover, Magnusson says upward pressure on long-end yields is kept in check because positioning in the steepener trade is still a little crowded. He said the more speculative investors haven’t been swept out because they’re not yet convinced that the U.S. growth rebound has lost steam.

And then there’s the Federal Reserve, which is still buying $80 billion a month of Treasuries. That may not seem like much, as the Treasury prepares to sell a combined $112 billion of three-, 10- and 30-year securities this week alone. But investors widely expect the central bank to ratchet up its purchases of longer-dated Treasuries, and a consensus is building that policy makers will confirm this as soon as their September meeting.

As for the inflation picture, this week’s data are expected to show consumer prices rising a touch faster, by 0.8% year-on-year. That would be a turnaround from the steep deceleration seen in March and April. It also jibes with a strengthening of market expectations for consumer-price gains, which has been reflected in an increase in breakeven rates for inflation-protected debt.

The 10-year breakeven has recovered from its swoon at the height of the market turmoil, and edged higher last week after the Treasury opted not to increase sales of inflation-linked securities even as it boosted the size of other auctions.

But that rate is still just around 1.6%, suggesting inflation won’t get anywhere near the Fed’s 2% target over the next decade. And against the current economic backdrop, price pressures are likely to remain relatively low on the market’s list of things to worry about.

What to Watch

• The economic data calendar
  • Aug. 10: JOLTS job openings
  • Aug. 11: NFIB small business optimism; producer price index
  • Aug. 12: MBA mortgage applications; consumer price index; real average earnings; monthly budget statement
  • Aug. 13: Import and export price indexes; weekly jobless claims; Bloomberg consumer comfort
  • Aug. 14: Retail sales; nonfarm productivity; industrial production; business inventories; University of Michigan sentiment
• The Fed calendar
  • Aug. 10: Chicago Fed’s Charles Evans
  • Aug. 11: Richmond Fed’s Thomas Barkin; San Francisco Fed’s Mary Daly
  • Aug. 12: Boston Fed’s Eric Rosengren; Dallas Fed’s Robert Kaplan; Daly
  • Aug. 13: Atlanta Fed’s Raphael Bostic
• The auction calendar
  • Aug. 10: 13-, 26-week bills
  • Aug. 11: 52-week bills; 3-year notes
  • Aug. 12: 10-year notes
  • Aug. 13: 4-, 8-week bills; 30-year bonds

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