Popular U.S. Treasury Trade Is Set to Unwind by Most Since 2017

Investors are pulling back from bets on a steeper Treasury yield curve -- one of this year’s most popular trades.

The strategy has come undone in July as investors flocked to longer-dated notes. The spread between five and 30-year yields has narrowed by about 17 basis points since the end of June, poised for the biggest monthly drop since November 2017.

Popular U.S. Treasury Trade Is Set to Unwind by Most Since 2017

Markets are beginning to reflect the possibility the U.S. Federal Reserve may compliment new forward guidance in September by buying more long-term debt. That’s prompted investors to reevaluate the so-called steepener trade.

Demand for longer-dated Treasuries is so robust that the bonds have outperformed swaps despite the record issuance slated for August -- an event that would usually favor the latter. Thirty-year swap spreads -- the difference between the two -- have climbed nine basis points this month to minus 40 basis points.

Popular U.S. Treasury Trade Is Set to Unwind by Most Since 2017

Difference of Opinion

Wall Street strategists, however, disagree on what the Fed will do next.

On the side of those betting against a steeper curve is TD Securities, which expects the Fed to extend its quantitative easing to longer-dated bonds and strengthen its “outcome-based” forward guidance in September -- a move that could lead to further yield curve flattening. The bank is recommending investors buy 10-year Treasuries and position for wider 30-year swap spreads.

Morgan Stanley’s Guneet Dhingra counters by saying it’s likely the Fed’s bond buying stays on its current course. That “could steepen the curve as some of the recent flattening could be unwound,” he said.

For Citigroup Inc.’s Jabaz Mathai, the Fed doesn’t need to buy Treasuries to keep a lid on expectations for higher yields, because swaps suggest rates will be unchanged for more than five years. And given the upcoming increase in Treasuries supply, it makes sense to be bearish on bonds into August, he said in a recent note.

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