A readjustment of expectations among traders and investors about when central banks might raise policy interest rates in the face of an uncertain economic outlook continued to be reflected in bond markets Thursday, with yield curves flattening further from the U.S. to the U.K. and Australia.
The moves were especially pronounced in the U.K., where the spread between 5- and 30-year government debt yields flattened to the narrowest level since at least 2008, according to data from Tradeweb. Meanwhile, the counterpart U.S. and Australian spreads were at their narrowest levels, respectively, since March and April of 2020.
Though individual central banks like Brazil’s and Mexico’s have already raised their benchmark interest rates, a more global rate-hiking cycle is expected by investors as soon as next year, even as growth appears to be slowing.
Data released Thursday showed that U.S. GDP growth slowed sharply to a 2% annualized rate in the third quarter. Meanwhile, investors continued to price in rate increases by the European Central Bank, while dismissing President Christine Lagarde’s effort to push back against such expectations.
“The global flattening of the yield curve will remain thematic in the coming weeks,
as market participants adjust to the realities of a more hawkish international monetary policy skew,” said Ian Lyngen, head of U.S. rates strategy for BMO Capital Markets.
The moves are coming at a time of increasing uncertainty about the strength of economic recovery, “and there’s more repricing to be done, but it’s not going to be in a straight line,” Lyngen said via phone Thursday. “It will be choppy. There will be moments of tactical re-steepening as we push flatter.”
In the U.S., the Treasury yield curve has been flattening ahead of next Wednesday’s Federal Reserve policy decision, in which an announcement is likely to be made on the tapering of $120 billion in monthly bond purchases. Tapering, the prerequisite first step toward a rate hike, would ordinarily have a tendency to cause long-end yields to shoot higher. Instead, long-end yields have been dropping over recent days, with the 10- TMUBMUSD10Y, 1.560% and 30-year rates TMUBMUSD30Y, 1.934% notching their biggest one-day declines since July on Wednesday before bouncing back on Thursday.
JPMorgan Chase & Co. strategists Marko Kolanovic and Bram Kaplan attributed Wednesday’s large moves in markets partly to significant month-end rebalance flows into bonds and out of equities, along with media reports of funds closing steepener positions at a loss. Other analysts, however, suggested technical factors had less to do with the moves than macro considerations did.
“Bond yields are on the move as traders reassess or continue to assess expectations of future central bank policy,” Stifel Nicolaus & Co.’s chief economist Lindsey Piegza wrote in an e-mail.
“Some insist the pullback is a reflection of industry insiders grappling with an end to significant fiscal support prompted by a solid recovery which in turn will lead to a more abbreviated timetable for a reduction in monetary support,” she said. “More likely, however, at least some investors are responding to the not-so-transitory-transitory inflation levels and declining growth expectations.”
In the U.K., the Bank of England’s new chief economist Huw Pill told the Financial Times in an interview published last week that inflation could rise close to or even exceed 5% in coming months. Not even an unexpected slowdown in one U.K. inflation gauge was enough to dent interest-rate hike expectations last week.
On Thursday, Treasury yields remained higher across the board, with the 5-year rate advancing at a faster pace than the 30-year yield. Meanwhile, U.S. stock indexes rose, as strong corporate earnings results continued to roll in. The S&P 500 Index SPX, +0.19% and the Nasdaq Composite Index COMP, +0.33% each closed at record highs, rising by 0.98% and 1.39%, respectively. The Dow Industrials rose 0.68% to reach the third highest close in history.