Whether it's the Fed cutting interest rates or Trump taking office, there seems to be a type of transaction that can benefit from it right now: betting on a steeper US bond yield curve.
In the past week or so, as Trump's chances of winning the presidential election skyrocketed after the first debate, and last Friday's non-farm data showed a further cooling of the US labor market, the trend of steepening the yield curve has begun to emerge. Many traders expect that the upcoming US June CPI data to be released this week may provide more support for this trading strategy.
Note: Schematic diagram of the spread between 2-year and 10-year US Treasury yields
After Biden's poor debate performance on June 27th increased the probability of Trump re entering the White House, the yield curve suddenly steepened. Citigroup, JPMorgan Chase, Morgan Stanley and other Wall Street giants called it one of the preferred "Trump transactions": its logic is that the Republican Party's policies on tariffs, immigration and deficits will push up the yield premium of long-term treasury bond.
This is mainly due to two reasons: on the one hand, the fiscal deficit exacerbated by Trump's series of tax cuts may further increase the scale of US borrowing, endangering the credibility of long-term bonds; On the other hand, Trump's high trade tariff baton may further trigger inflation, thereby driving the recovery of long-term bond yields.
Morgan Stanley stated that the likelihood of Trump winning the US presidential election is increasing, in which case US economic growth may slow and inflation may accelerate, making it attractive to bet on a steeper US bond yield curve. Da Mo strategist added that the market must now cope with the increasing likelihood of changes in immigration and tariff policies. Against the backdrop of increasing concern about deficits, the likelihood of Republican victory may pose an upward risk to long-term US Treasury yields.
It is worth mentioning that the trading strategy received another boost last Friday - this time the triggering factors were no longer limited to the political situation, but also further boosted the Federal Reserve's interest rate cut prospects this year due to signs of a weak US job market, leading to a significant decline in short-term Treasury yields more closely related to expected interest rate changes.
The difference in yields between 5-year and 30-year US Treasury bonds reached its highest point since February after the release of non farm payroll data last Friday.
The loose policy of the Federal Reserve is being seen by many industry insiders as another major driving force that may stimulate the steepening of the yield curve, which has sparked market attention to this week's inflation data. According to media surveys of economists, the year-on-year increase in US CPI in June may be the lowest since January.
Cindy Beaulieu, Chief Investment Officer of Conning North America, said that the steepening of the yield curve caused by inflation and fiscal policy may continue.
Of course, there are fundamentally some differences in the steepening trend of the yield curve caused by the Trump deal and the expectation of a Fed rate cut, respectively. The Trump deal has triggered more of a "bear steepness" in the bond market - the yield on US Treasury bonds of various maturities may mostly rise, but the increase in long-term bond yields will be greater than that of short-term bonds; The expectation of the Federal Reserve's interest rate cut will inevitably lead to a sharp decline in the bond market - the overall yield curve of US Treasury bonds will decline, but the decline in short-term bond yields will be faster than that of long-term bonds.
Ira Jersey and Christopher Cain, macro strategists, said that although the yield curve of treasury bond bonds may remain steeper in the short term, we believe that once the Federal Reserve starts to cut interest rates, the recent "bear steep" may soon end and turn to "bull steep". From time to time, there may still be flattening of the yield curve, mainly related to the short-term yield trend, which also indicates that the Federal Reserve's monetary policy is the key to determining the direction of the yield curve.
At present, strategists at Dao Ming Securities predict that the yield difference between 5-year and 30-year US Treasury bonds may eventually reach 100 basis points. Since last year, Dao Ming Securities has held this view, and the Federal Reserve's interest rate cut policy is an indispensable factor. Gennadiy Goldberg and his team from Daoming Securities wrote at the end of last month that regardless of which side wins the November election, the threat of high deficits is also indispensable.
Note: Schematic diagram of the 5-year and 30-year spread of US Treasury bonds
Greg Wilensky, head of fixed income at Janus Henderson Investors in the United States, stated that he is moderately pricing for a steeper yield curve, currently over allocating the five-year portion of the curve and under allocating longer term bonds. He believes that economic conditions rather than political games will be the main triggering factor for this strategy. He said, "The data we will see is expected to increase the likelihood of the Federal Reserve achieving a soft landing, and the Federal Reserve can start cutting interest rates, which will help steepen the yield curve."
Of course, there are also some market participants who are skeptical about trading with steeper yield curves at the moment. Goldman Sachs strategists predict that by the fourth quarter, the difference in yields between 5-year and 30-year US Treasury bonds will remain largely unchanged at current levels.
Goldman Sachs strategist Bill Zu pointed out that during Trump's presidency, he launched a trade war where tariffs put pressure on productivity and economic growth, resulting in a decline in yields and a flattening of the curve. In addition, the difference in the US deficit outlook under Biden and Trump policies is relatively small, indicating that any supply driven rate of return reassessment based on elections should not be too obvious.