The desk believes that the recent shift from steepening to flattening in global yield curves signals a broader trend influenced by central bank policies and market positioning. Per the full note source, this transition is particularly evident in the US, UK, and Eurozone, where flattening pressures have emerged as a response to changing economic forecasts and inflation expectations. The desk highlights that the flattening trend could indicate a market reassessment of growth prospects and interest rates, particularly as central banks navigate their monetary policies. With no high-impact events on the calendar in the next 30 days, traders should remain vigilant for any shifts in economic data that could further influence these dynamics.
What the desk is arguing
BofA Global Research highlights a notable shift in global yield curves from steepening to flattening pressures, driven by divergent monetary policy expectations and economic data across regions. The discussion covers technical indicators and trade implications for US, UK, and EUR rates.
Where it sits in our coverage
Our internal consensus leans toward a modest steepening in the near term, but the shift described aligns with a cautious flattening bias. The firm's spread view suggests a neutral stance, with a slight lean towards flattening in the long end.
How other firms see it
Goldman Sachs: Maintains a steepening bias, citing persistent fiscal spending.
JPMorgan: Expects continued flattening on growth slowdown fears.
Deutsche Bank: Neutral, awaiting clearer policy signals.
Key takeaways
01Global yield curves have shifted from steepening to flattening pressures.
02The change is attributed to evolving monetary policy expectations and economic data.
03Technicals suggest potential flattening trades in US, UK, and EUR rates.
Market implications
The flattening trend may pressure long-end yields and favor duration-neutral trades. Curve steepeners may unwind, and carry trades could shift towards front-end positions.
Risks to this view
Key risks include a sudden repricing of rate expectations due to inflation surprises or central bank hawkishness, which could reverse the flattening momentum.
Hello, and welcome to Global Research Unlocked, the interest rate and effects series. This podcast is based on our weekly client conference call where our strategists, along with guests from other parts of BYA Global Research, discuss the most topical and pressing questions faced by our market. I'm Ralf Preusser, head of Global G10 rates and effects strategy.
Today is Friday, 27th of February. I'm joined today by Paul Siena, head of technical strategy, Suya Salim, head of European rates strategy, and Megan Swiber from our US rates strategy team. Thank you all for joining.
Megan, let's start with you. The curve steepened, the dollar curve steepened long and underperformed on asset swap on the IEPA ruling from last week. Why are you saying that is a fade?
Maybe just to start, the modest steepening that we saw at the back end, as you mentioned on asset swap and curve bear steepening, that price action that we saw was very consistent with what we were expecting. It was modest, and we think a lot of that was driven by the fact that it was well-priced by the market. But importantly, as we're going to discuss, really, the IEPA ruling does increase deficits modestly, but these increases are just not big enough to change what we're expecting from a duration supply impact.
We expect Treasury to hold auction sizes steady until the Feb 27 refunding, and for now, really lean more heavily on bill supply, especially with these Fed bill purchases that are ongoing here. And when economists look at this deficit impact rate between the combination of the IEPA ruling and Trump's 15% broad-based effective tariff rate that he's likely to enact to replace IEPA, it's about a 1.5 percentage point lower effective tariff rate near term. After Section 122 expires, the deficit impact will become larger.
With effective tariff rate, we expect a decline by closer to three to four percentage points, which increases deficits a little bit more. We have a 20 to 30 basis point impact on deficits from fiscal year 2027 all the way out through our 10-year time horizon. But importantly, when we look at these deficit impacts and we're trying to square what it means for that bill issuance number, what it means for the bill allocation, when we run the bill percentages through fiscal year 2028, keeping our coupon supply forecast constant, that bill share impact is less than one percentage point.
And when we look at these numbers just in raw terms, if you assume that tariff refunds happen, it increases bill supply by about $400 billion over those three fiscal years. And without refunds, it's closer to $200 billion. So these numbers, we think, are really going to be still well digested by the market.
For us, it really is just not changing our expected timing around when Treasury will be pulling forward that coupon increase. We still have Feb 27 as the timing on that. And again, really think this increase in bill supply will be well digested by the market.
And we have a Treasury right now that has made pretty clear that they're going to be funding more heavily through bills right now with consideration of what the Fed's doing. Thank you for that. Now, the other thing that you did as a team is to close the long-held steepening bias, at least in outright terms.
Brunner still likes it conditionally. How much of that is a view that the Fed is now more fairly priced? Yes, that's a big part of our decision, I would say, to take off the steepening bias that we've had on.
We've been recommending being long belly of the curve. Just right now, we see the market likely pricing trough. It's a little bit more equitable in terms of distribution of risks around it.
And so when we think about the pressure for the curve to steepen from here, there's just less bull steepening dynamics going on. And then at the same time, as we'll discuss in a bit, we see less bear steepening risks here as well. At this point, too, when we're looking at market pricing for Fed near term, we do like being paid June FOMCOIS.
We think that the market should fade that worst premium that's been assigned to June, which the market is doing. And since we've put this position on, the Fed right now does seem to be focused more on being on hold. We see that in the minutes.
And labor data in particular has been firmed. Generally see less risk for the curve to steepen from a bull perspective here. And as we'll discuss, less from a bear perspective as well.
The other thing that you flagged this week is that you think the inflation curve is too steep. I guess that's also a contributing factor. Yes, we think it actually makes sense to set up for a flatter inflation curve here.
Our economists are calling for stronger growth and more supported services inflation over the next year and a half versus what is likely implied in market pricing right now. And when we think about the AI disinflation tailwinds, we think that's going to be more of a medium to longer term theme. The other thing that, of course, happens with inflation markets is that the front end becomes very heavily correlated to equity markets.
And given some of the recent risk off that we've seen here, we get an unwind of that. We see more room for the front end of the inflation curve to be more supported. Also think that if we get a spike in oil prices or alongside a build in geopolitical risks, that should also help support a flattening of the inflation curve as well.
Great. And then last question for you, and we talked about this last week already, but what is driving the support for the back end of the Treasury curve? Yeah, I think three things, Ralph.
So the first, and we see this in our FX and REIT sentiment survey in a number of ways, is that a lot of clients that we speak to had been favoring the steepener because of this risk around Fed independence. Generally see risks of that abating here, given Warsh's Fed chair nominee, given the fact that the Supreme Court ruling on IEPA suggests that they would be willing to rule against Trump again on the Cook case. And the most recent arguments also suggest that they're leaning in that direction as well.
So do see some repositioning on curve purely driven from that. And if you're in a steepener, closing some of that position, of course, creates a natural bid for the back end. The other two things that I would mention, and we spoke a little bit about this, is from a fiscal perspective in terms of how Treasury is going to fund deficits, with them talking more about accounting for what the Fed is doing with its balance sheet.
Of course, the Fed right now is doing bill purchases through their reserve management purchase program that allows Treasury to fund more heavily through bills. So this upside shock or any upside shock deficit can be funded more heavily through bills versus duration supply for now. And then the third factor that we see, and we saw it yesterday as well, is that the back end is beginning to diversify more versus risk.
Back end is not necessarily outperforming when we see a risk asset fell off the belly is still the place that's doing the best there. But we are still seeing back end rally. And when we look at cross-asset correlations, last April following Liberation Day was the big shift in these correlations where the back end was not diversifying versus risk.
It was more positively correlated with risk. And that diversification benefit that we see out there is allowing asset managers to look at some of these quite high real yields, quite high nominal yields, especially in some of these forward constructions, and allowing them to extend that duration. And indeed, Ralph, that's what we're seeing in a lot of our flows and positioning reports that we write on as well.
Thanks, Megan. Paul, sticking with dollar rates, you've written about exothermic triangles, which I don't think is a term I've come across in my career before. Enlighten us.
Yeah, that word doesn't get your attention. I'm not sure what does. And sitting in the Northeast, anything that says warming up is a welcoming term to me.
But in the context of US rates and triangles, we look at the yield charts and we see how yields have compressed to the narrowing ranges formed by horizontal, but more so converging trend lines. And extended periods of compression are eventually accompanied by some sort of release, such as a market that heats up. And yields exit that pattern with a spring-like directional move.
So these ranges have become so tight, the swings between these converging lines are becoming due for a directional breakout and exiting of that pattern. In this environment of breaking out, yield volatility has also compressed and can amplify and extend the moves in a directional way as these patterns evolve. So overall, yields are still trading within these narrowing ranges.
It's actually not until today where it's starting to look a little interesting to see US 10-year yield starting to break below 4%. What we explained in our last report is that the big level to have the cyclical bull market environment persist is about 3.93%. So I hope everybody keeps that level on their notepad, because if 10-year yield falls below that, we'll finally have a lower low in the chart, which we haven't had since 2024.
I've just written the number down. How much of that compression and breakout story is a story about yields, and how much of this is a story about curves? It's likely a story about both.
I think in the curve space, there's a bit of a different dynamic going on between what I see in recent price action in 2s 10s versus 5s 30s. We step up to a larger timeframe, and 2s 30s is actually forming one of these exothermic triangles as well, and is still stuck between these converging trend lines and has yet to break out. I would say the constructs of overall trend following technical theory would say that this triangle in 5s 30s could resolve to the upside while above 97 basis points.
Similarly, in 2s 10s, that had a triangle back in 2025, and it broke higher out of it and steepened. It's now correcting within the constructs of a multi-year uptrend, and may be a scoop towards 50 basis points for a resumption of that move steeper. Great.
Then end of February is upon us, March is just around the corner. Apart from it hoping that it gets warmer, especially where you are, is there anything else that tends to happen in March? In the rate space, there is some interesting takeaways.
First of all, average trends for US yields and global yields in March are slightly higher in yield, not by much, two, three, four basis points. Because there's a good amount of history going back to 1960, 1970 that we can look at, we actually checked what happens in year two of the US presidential cycle in the month of March. We have about 12 observations, which is not high, but it's certainly not low.
And 11 of 12 times, the two-year yield actually rose in March by about, on average, 18 basis points. So one of the things that we could see in March is if the two-year yield follows that pattern, then we might still see some more of that 2s 10s flattening that Megan was mentioning, on those lower levels, like 50 basis points, and the test of that multi-Europe trend. Great.
Thank you, Paul. So yeah, let's talk about Europe. The Eurocurve steepener was very much talked about into year-end.
It hasn't really materialized. Why do you think that is? Yes, hi.
Indeed, January disappointed when it comes mainly to long-end paying pressure from Dutch pension funds. That was the big theme heading into January, but flows actually were skewed more towards the receiving side, especially in ultras. There are a few explanations on the pension fund side, besides their paying needs maybe being a bit below expectations.
I think the first one is that you have pension funds that have transitions that are spreading their paying needs in the long-end over the next few months still, up until middle of the year, probably. Secondly, you have in ultras maybe some pension funds that had not hedged their rates exposure uniformly and instead, after transition, they had received positions that were not large enough to satisfy the risk-free exposure required for young members, leading them to actually receive swaps in fourth-year and fifth-year part of the curve. The last explanation could be that there could have been appetite from the pension funds that haven't transitioned yet to actually receive rates.
That could be because they indexed pensions and therefore needed to receive to keep their hedge ratio constant, or it could be also because they want to further protect their financial position ahead of their switch to DC later this year or in 2027. Great, thank you. Now, the lack of steepening or indeed flattening in long-ends hasn't just been a European story.
We've been able to observe that globally. How should we think about what the euro curve has done in that global context? Yes, if we just go back to pension funds for a second, I think that in the next few months the set of behaviours we could see from them can be quite diverse.
You can get to some that are still paying, as I mentioned, and others receiving to further hedge their ratios. So I think that overall pension fund flows may offset each other and may not be a major driver for the curve near term. And that's where it makes sense to look at global dynamics here and look at other factors that could be more relevant.
I think that here I would highlight five of them in particular, and they would tend to point to some flattening potential in the near term for 10s, 30s. The first would be the reduced supply pressure. I think that we're now past the most intense period of the year for EGB issuance.
We're looking at a drop in the DV1 of supply in March in themselves versus the first two months of the year. Secondly, we have demand from insurers that are now getting a lot of inflows. If you look at French insurers in particular, they're seeing their largest yearly inflows in 25 of the last 10 years, and they can be buying bonds.
The third element is the macro with an ECB that is still hawkish. I think that the curve can still be prone to flattening. And then there is positioning a bit like in the U.S. where you still have shorts in the long end that are out of the money and that could be stopped out, and positioning in steepeners as well that can be stopped out.
And finally, global dynamics. I would say all of the factors I highlighted are also linked to or similar to what we see elsewhere. But I think that the global dynamic is also a key factor for the euro curve because we're in a way unwinding the big steepening views that everyone had in the big cheapening or build-up in term premia that we saw last year.
It's starting with 2.10s, but I think it can now extend more into 5.30s. Great. Let's pivot to the U.K.
We're also coming up to the next gilt remit. What do we expect? So two things.
One is a substantial reduction in gilt sales for this fiscal year. We estimate gilt's gross supply could be down by $69 billion to $235 billion. And the second element is a further reduction in the maturity of issuance.
For the decline in size, I would say that we're actually a bit conservative here. $69 billion is a substantial number, but we're only assuming that part of the overfund we're currently running for the fiscal year, only part of it will be captured by the DMO for their gilt supply protection. And when it comes to the reduction, I would say that it's going to be interesting in terms of how it is engineered. We think it will come with more bill supply, $15 billion in our view can be raised by bills, and also a meaningful reduction in the medium bucket of issuance, but more coming in shorts.
But all of these details will clearly be relevant for the U.K. curve. And I would flag in particular the U.K. watch that Sonali and Agne published yesterday on the topic of the spring forecast for more detail. Great.
But I will ask you about what it means for the curve. You've already mentioned it. Yeah.
So I think for us, there is scope for a bit more flattening, but we're more comfortable with that view for two-year, 10-year part, as opposed to further out. And that comes back to my point here, the reduction of issuance being the largest, in our opinion, in the medium bucket. If we're right, then the 10-year sector, which appears quite cheap at the moment versus Sonia, as well as treasuries and bunds, that sector can really be the one to benefit the most from the announcement, and that can drive a two-year, 10-year flattening.
Great. Thank you, Svea. Thank you, Megan.
Thank you, Paul. Thanks for joining us today. We hope you found this useful and that you'll tune in next week.
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