US Rates: Yield curve bull flattens ahead of September FOMC
The desk interprets the recent bull flattening of the US yield curve as a signal of increasing market caution ahead of the upcoming September FOMC meeting, reflecting expectations of renewed vigilance from the Federal Reserve. Per the full note by J.P. Morgan, this move may be attributed to diminishing inflation pressures, which are leading investors to reassess their interest rate outlook. This sentiment aligns with broader assumptions regarding a potential shift in the Fed's monetary policy stance amid seasonal corporate tax deadlines. The current dynamics suggest traders should remain vigilant as fluctuating expectations could impact the USD's relative strength significantly.
What the desk is arguing
The desk views the recent bull flattening in the US yield curve as indicative of a cautious market poised for possible dovish signals from the Fed ahead of the September FOMC meeting. This interpretation is strongly supported by observed shifts in inflation expectations and Treasury yields, which have slid as traders anticipate a credibility test for the Fed in managing ongoing inflation concerns. Per the full note source, the flattening is characterized by a more pronounced dip in long-term yields, showcasing a risk-off sentiment in the market.
Moreover, the September corporate tax day is anticipated to further influence market dynamics by driving liquidity conditions and altering the demand for short-to-medium term Treasury instruments. With such influences at play, the desk believes the current rate environment could sustain pressure on the USD's positioning as traders react to policy cues.
Where it sits in our coverage
Our current consensus target for USD positioning is set at 1.075 within a range of 1.04 to 1.12. Notable views include jpmorgan with a target of 1.10 for Mar26 and bofa forecasting 1.04 for the same tenor.
This view is aligned closely with J.P. Morgan's position, which reflects confidence at the higher end of the consensus spread. The market is showing a more cautious approach as expectations of Fed policy adjustments loom, potentially influencing currency strategy significantly.
How other firms see it
Many firms, including jpmorgan and gs, are aligned in anticipating a dovish pivot from the Fed, which would support a weaker USD overall. Conversely, firms like bofa are more skeptical, projecting a stronger dollar in the near term amid resilient economic data.
In related dynamics, the EUR/USD trajectory may be illustrative of broader dollar movements to watch, alongside any shifts coming from anticipated Fed policy adjustments that could redirect investor sentiment significantly.
01Bull flattening of the yield curve indicates market caution
02Upcoming September FOMC meeting could hint at dovish Fed signals
03Corporate tax day might influence liquidity conditions
04Current positioning suggests a potential weakening of the USD
Market implications
Pay close attention to the USD's performance against major pairs in light of the flattening yield curve, particularly noting potential levels around 1.075 as traders position for Fed signals. The September corporate tax deadline could create volatility in the short-term bond markets that may lead to increased dollar strength or weakness.
Risks to this view
Any unexpected hawkish signals from the Fed or stronger-than-anticipated economic data could invalidate this cautious outlook, leading to a selloff in Treasuries and a rapid adjustment in yield expectations. A robust print in inflation metrics could also challenge current positioning.
Welcome to At Any Rate, J.P. Morgan's global research podcast. I'm Phoebe White, senior rates strategist and head of U.S.
Inflation Strategy. And today I'm joined by Ipek Ozil, head of U.S. Interest Rate Derivatives Strategy, to discuss our latest thoughts on the rates market following another volatile week.
And all the attention was at the long end of the curve this week, where we saw a complete reversal of the late August evening move. After touching 5 percent mid last week, 30-year treasury yields fell as much as 36 basis points from their local highs, touching 4.64 percent yesterday, and are trading a touch above that level this morning, Friday, September 12th. So Phoebe, what do you make of the relentless flattening this week?
So I think I would highlight three pieces to this. So first, a fundamental element. Second, technical element related primarily to position unwinds.
And then third, some mean reversion from very steep valuations in the curve. So first, just on fundamentals, there was clearly a strong bid for duration coming out of the August employment report last week. I think concerns around the labor market were still clearly in focus this week.
We had a 911,000 downward revision to employment in the preliminary benchmark revision. Initial claims also jumped 27,000 to 263,000 in the latest report. It does look like that jump was related to an increase in fraudulent claim attempts in Texas.
We prefer to fade that increase, but the data was, of course, in focus. And then on the inflation front, PPI came in softer than expected. CPI was right in line, but perhaps not as strong as feared.
So I think all these things contributed to the bid for duration. I think what's interesting, though, is that the decline in yields was so concentrated at the long end, as you mentioned. On the front end, we've actually seen yields move a touch higher.
So with respect to the curve, I would highlight this more technical element. The front end, of course, had significantly outperformed in the rally throughout the summer. I think market-implied terminal has faced some resistance here near that 290 area.
That's a level that implies a Fed easing into accommodative territory. And meanwhile, longer run-forwards had lagged in the summer rally, 30-year yields. As you mentioned, we're still trading near 5% last week, and demand really started to shift out the curve here.
I think position unwinds exacerbated the move. So for example, we estimate that active core bond funds had been underweight duration heading into this week and had increased curve steepener exposure over the summer. So it's likely some of that positioning was unwound throughout the week.
Yields also crossed through some key momentum thresholds, so CTA buying likely contributed to the rally as well. And then third, I would just highlight the mean reversion element here. So if you look at the curve versus our own fair value framework, the broad 5's 30's curve had traded about 15 basis points too steep versus its fundamental drivers about a week ago, and that residual has completely reversed.
The curve now actually appears a touch too flat on this basis. So I think all of these elements contributed to the strong bull flattening move that we saw throughout the week. Thanks Phoebe.
And I guess looking ahead to next week, we have the FOMC meeting coming up. What are you expecting to learn and what do you think this means for the near term direction of travel for yields? So we expect the Fed will deliver a 25 basis point cut as is fully priced by markets.
I think there will be some focus on the vote split given the dissents that we got at the last meeting. We think there will be probably two or three dissents for a larger than 25 basis point cut. One of those likely coming from Stephen Mirren, who we think will be confirmed by the Senate in time for next week's meeting.
Of course, focus will also be on the SEP and the forward guidance in the statement. In the dot plot, we think the median for this year will continue to show one further cut beyond the expected action taken next week. So two cuts total for the year.
There is a risk it could show three. And then for next year, we think the dot will show a median of two cuts before getting back to neutral or 3% in 2027. In terms of forward guidance, we don't think Powell at the presser or the post-meeting statement will give any firm guidance on cuts beyond next week's meeting.
And in that context, I think it will be difficult for the Fed to deliver a dovish surprise relative to market expectations. OAS rates are currently implying around 145 basis points of easing by the end of next year. So taking all this, we think that risks are actually skewed towards higher yields over the near term, particularly further out the curve.
I think the front end could stay fairly well anchored here. But the tenure sector in particular does look rich after this week's moves. So tenure yields are about 17 basis points or so below our fair value estimate.
And the sector really stands out as rich on the fly after adjusting for the level of rates and the shape of the curve. And I think just taking a step back, fundamentally, we think a Fed that is on track to deliver a series of insurance cuts to protect the expansion, even with core inflation running above 3%, should allow downside growth concerns to fade a bit here and also for longer run inflation expectations to move higher. But let me just turn it back to you, Ipek, because in addition to next week's macro events, we also have corporate tax day on Monday.
There are some concerns around what this will mean for funding markets and of course the implications for swap spreads. What do you think about spread valuations here? Yeah, that's right.
Corporate tax day is on Monday. And one of the questions that we've received a lot in the past few weeks is that whether we're in for another so-called apocalypse, similar to what we experienced in September 2019. In short, we think the answer is no.
But we do think that the funding markets will have some frictions in the next couple of weeks with corporate tax day and also quarter end approaching. But going back to your question, it makes sense that why we're getting asked this question on corporate tax day. We've seen so far printing higher in the past week.
It's kind of similar to what happened in 2019. Again, similarly, we're in a TGA rebuild phase and the Fed is continuing its QT. And in the past few months, overnight RRP facility usage declined from $200 billion to around $20 billion.
And that's likely a floor on how low overnight RRP balances can go. And if we were to look at reserves, they've been very steady since March 2023, which likely reflects banks' preference for reserves in light of SVB events or, again, in a related manner, a change in internal liquidity requirements. So you know, all of these things point to the fact that it could happen again.
But there are also a few things that are different, which actually make all the difference. One, reserves are still pretty ample. And one way you can see that is by looking at reserves to GDP ratio.
And back in 2019, this was near 7%, while we're now near 10%. So that to us tells us that even if we assume banks want more reserves than they did in the past, there is still some room and that they could land in repo markets. And two, SRF is in place.
And there have also been a lot of discussions on de-stigmatizing using of the Fed facilities. So all of these combined, we don't think or we don't expect a 2019 event. But as our short-term colleagues noted, they are expecting firm funding conditions early next week and also around month-end, quarter-end.
So what does this mean for spreads? So in the front-end, this means there are offsetting factors. On one hand, you have positive carry from longs in spread positions, but the funding pressures could point to narrower spreads.
So you have kind of offsetting pressures. And it's also kind of what we saw this week when the front-end narrowed significantly compared to the long-end. For the long-end, the story is a little different.
The long-end doesn't offer as much carry. So this funding pressure could be something that pressures long-end spreads narrower, also along with some seasonals. Thanks for that.
And lastly, let's just touch on options markets. implied vol, of course, has continued to come down across the surface. What do you think about valuations on the vol surface here? Yes.
So implieds have been kind of like a one-way train lately, and that's down. And since the spike in implieds in early August, they've just been headed lower. And this likely has to do with the fact that, I guess, one, yields are lower, but also the fact that the distributions around Fed policy, at least for this year, has been tightening.
So as you mentioned, we're looking for one cut next week, and markets are priced to three cuts by December. But if you look at the implied distributions from options markets, that distribution also has been tightening with the tail risk kind of being removed. And on top of that, selling vol is a good way to uncarry when you're not expecting a lot of jump risk in markets.
So all of these factors have been pointing to lower vols in the past few weeks. But where are we now? We can say shorter tails look slightly rich versus longer tails.
And we think tightening of the distributions should impact shorter tails more so than the longer tails. And longer tails can also be exposed to any Fed independence concerns or longer term inflation concerns should they arise. So maybe let's just leave it there for today.
We look forward to continuing the discussion next week on At Any Rate. This communication is provided for information purposes only. Please read JPMorgan research reports related to its contents for more information, including important disclosures.
Copyright 2025 JPMorgan Chase & Company. All rights reserved. This episode was recorded on September 12th, 2025.