Yield curve steepening is a little-noticed bond-market development that could put many borrowers on edge. Big moves in stocks and cryptocurrencies have commanded the lion’s share of investors’ attention this week, but things are also unfolding in the bond market that could have big implications for borrowers this year.
A trading pattern known as a steepening of the Treasury yield curve gained momentum this week. If this dynamic remains in place by the time the Federal Reserve is ready to cut interest rates this year — or when traders solidify their expectations on the timing of such a move — it will likely be harder for consumers and businesses borrowing over a long-term horizon to enjoy the full benefits of lower short-term borrowing costs.
On Thursday, signs of a weakening U.S. labor market caused traders to boost their expectations for a Fed rate cut as soon as March and to price in a slightly greater chance of a total of three or more reductions by year-end. The policy-sensitive 2-year Treasury yield fell at a faster pace than the rate on the 10-year note as a result. That pushed the spread between the yields on the two notes to one of its widest levels in four years, at 72.8 basis points.
Generally speaking, a steepening curve is often associated with a brighter U.S. economic outlook and an environment in which banks are encouraged to lend more freely because they can also borrow more cheaply.
This time around, though, something a bit different is going on. Yield curves are steepening around the world — including in Japan, Germany, the U.K. and Canada — because of a sense that “governments are adding to fiscal stimulus and concerns are growing around the sustainability of that,” according to Tom Nakamura, head of fixed income and currencies at AGF Investments in Toronto.
In the U.S., the Treasury curve has more room to steepen relative to bond markets in other countries for a number of reasons, Nakamura said in a phone interview on Friday. Those reasons include worries about an “overreaching” White House that may interfere with the Fed’s independence and push for lower interest rates, which could then result in inflationary pressures and investors demanding more compensation for the risk of holding long-term Treasurys, he said. Read more related Finance news.
The Impact of a Steeper Curve
A Treasury curve that remains steeper around the same time the Fed is ready, or expected, to cut rates translates into a more difficult time for consumers or businesses looking for mortgages or long-term loans. This is because under that scenario, loans priced off of 10- and 30-year yields would not be moving down in lockstep with the Fed’s rate move. Now that the Fed has kept rates unchanged in January and has purchased more than $90 billion of Treasury bills since December, long-term borrowing costs have more or less stabilized.
A steeper curve “makes it harder to get by on those things that matter to consumers: credit-card debt, which carries short-term rates with a very large spread to the Fed’s policy rate, and mortgages,” Nakamura said. “That’s where yield curve steepening matters. Even if the Fed lowers policy rates to stimulate the economy, borrowers may not get as much benefit from this on new mortgages or even with auto financing, which covers two- to five-year periods.” Meanwhile, companies looking to finance over a 10-year period or more would find the cost of doing so to be more expensive, he added.
“A steeper curve makes it harder to get by on those things that matter to consumers.”
On Friday, financial markets were recovering from what has been a bruising week stemming from jitters over artificial-intelligence spending, along with tumult in bitcoin and metals. All three major U.S. stock indexes traded sharply higher ahead of the closing bell, with the Dow Jones Industrial Average crossing the 50,000 mark for the first time, and U.S. government debt sold off slightly as investors embraced riskier assets.
That helped push the 2-year yield up to 3.5% and the 10-year rate closer to 4.21%. This left the spread between the two at 71.4 basis points on Friday, a touch narrower than in the previous session. The current yield curve steepening trend is worth monitoring.
Debt Concerns and the Future of the Yield Curve
Debt concerns “are not going away” and, if they persist, may leave the Treasury market “biased toward a steeper curve,” Nakamura said. But if the labor market falters in a way that raises expectations for weaker economic growth and softer inflation, this could flatten the curve around the time the Fed starts cutting rates. A flatter curve, he said, also has the potential to “offset fiscal concerns.” Keep a close eye on yield curve steepening.
Monitoring Bond Market Trends
The bond market is dynamic, and understanding trends like yield curve steepening is essential for borrowers and investors alike. The recent yield curve steepening is a significant development to watch.
Source: MarketWatch
