The Most Popular U.S. Bond Market Trade Has Now Gone Global

Strategists globally are converging on one bond market trade: betting on a steeper yield curve.

The strategy is gaining in popularity as two trends cause the curve to steepen. With short-end yields anchored by near-zero policy rates in major economies, Wall Street banks are arguing that a rebound in global growth paid for with new bond supply will send longer-dated yields climbing.

Whatever the shape of recovery, investors are positioning for an improvement even as the threat of a second wave of infections lingers and policy makers warn that uncertainties persist.

“There’s a realization that shutting down the economy entirely is just not feasible anymore and on that basis, there’s less reason for bond yields to head substantially lower,” said Prashant Newnaha, senior strategist at TD Securities in Singapore. “There’s also a lot of debt supply coming to hit the markets over the next couple of months.”

NatWest Markets Plc has been recommending German curve steepeners as they see the strong European policy response to the coronavirus as likely to spark some inflation, while the notes have lost their reliability as a macro hedge.

“Core market curve steepening has been a big theme for us in recent months and the Gilt curve now looks set to join the trend,” NatWest Markets strategist Giles Gale wrote in a June 19 client note.

Who’s Saying What

In the U.S., Wall Street banks have been lining up to recommend steepener positions in Treasuries. The rise in long-dated bond supply and scaling back of purchases from the Federal Reserve have hardened the argument.

Morgan Stanley recommends seven-year versus 30-year Treasury steepeners while JPMorgan Chase & Co. prefers five-year versus 30-year. NatWest uses U.S. dollar interest rate swaps to express 10-year versus 30-year steepeners.

Morgan Stanley Rejigs Treasury Trades, Sticks With Steepeners

Japan’s Supply Surge

In Japan, stimulus packages total around 234 trillion yen ($2.2 trillion) or over 40% of gross domestic product, and as a result debt issuance is being boosted.

With the Bank of Japan’s yield curve control tethering the 10-year point near 0%, and given the limited scope to increase longer-dated bond buying, investors expect long-end yields to come under pressure.

GS Recommends 10s30s JGB Steepeners on Growth, Demand Dynamics

Goldman Sachs Group Inc. and JPMorgan Chase & Co. both recommend 10-year versus 30-year government bond curve steepeners. Strategists at Morgan Stanley MUFG Securities Co. are looking for long-dated bonds to underperform against interest rate swaps.

U.K. Tug of War

There are two offsetting factors in the U.K. bond market. On one hand, borrowing increased by more than 100 billion pounds ($124 billion) in the two months to May, topping 100% of gross domestic product for the first time since 1963. And the trend is set to continue.

On the flip side, the Bank of England has boosted asset purchases by 100 billion pounds although it has slowed the pace of buying.

One side is winning out.

NatWest Markets looks to sell 30-year Gilts against U.S. Treasuries as slowing bond purchases begin to weigh on the market. JPMorgan strategists see a risk that bond yields will grind higher over the rest of the year as net bond supply turns more positive. Morgan Stanley expects higher yields and steeper curves.

— With assistance by Ruth Carson

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