With Deluge Of Treasury Sales On Deck, Curve Flattening Set To Return

Forgot Trump’s jawboning, ignore the BOJ’s threats to rock the JGB yield curve, the most important driver behind the shape of the Treasury yield curve – supply – is about to make another flashy appearance as the US Treasury sells $119 billion in note auctions this week, all with a maturity of 7 years or less, and starting with a 2 Year bond auction later today.

And while the yield curve has steepened sharply in the past two days amid fears of declining Japanese demand, whispers of Chinese selling and interest rate locks, the flattening may be set to resume as investors demand higher rates for shorter paper, much more of which is coming down the line.

As Bloomberg notes, curve flattening may resume as soon as today as traders digest 2-, 5- and 7-year auctions, including floating-rate securities. The fixed-rate coupons will cumulatively issue the most debt since 2013.

And then there is the Fed which continues to keep hiking, and according to many strategists, is approaching the so-called neutral rate of interest.

“Any in-range steepening is an opportunity to scale back into flatteners,” BMO rates strategist Ian Lyngen said. “It’s difficult to fade the flattener given the Fed’s commitment to normalize rates in spite of relatively low core inflation and the potential economic headwinds from the trade war.”

Here’s what’s on deck:

  • July 24: Treasury to auction $35 billion 2-year notes, $55 billion 4-week bills
  • July 25: Treasury to auction $18 billion in 2-year FRN in reopening, $36 billion in 5-year notes
  • July 26: Treasury to auction $30 billion in 7-year notes

The 2Year is $1 billion larger than last month’s, part of the Treasury’s gradually boost auction sizes as it plugs swelling deficits and makes up for the Fed’s shrinking balance sheet: by leaning on greater issuance of shorter maturities the Treasury is directly contributing to the yield curve’s collapse.

Looking ahead, on Aug. 1, the Treasury will unveil its latest borrowing plans, which analysts predict will see another increase in the size 2-and 3-year auctions by $1 billion per month, while also unveiling a one-time hike of $1 billion for FRNs as well as the 5- through 30-year tenors.

But a more important date to keep track of is July 31, when the BOJ unveils its next decision: should Kuroda do nothing and refute speculation that the central bank is adjusting its rate curve control, long end yields will likely tumble as the JGB curve normalizes.

The last case for a flatter yield curve will be unveiled on Friday when the U.S. will report its latest Q2 GDP which according to Barclays could print as high as 5.3%, the highest since 2003.

While a slowdown is expected in the second half, the number will be trumpeted by Trump, and will likely reaffirm Powell’s plan for further rate hikes, and even more flattening.

Powell “sees a clear reason to continue rate hikes as well as balance-sheet reduction, so we don’t think there’s anything that will give him pause at the moment,” said Mona Mahajan, U.S. investment strategist at Allianz Global Investors. She also sees inversion possible by year-end if the Fed sticks to its path.

Meanwhile, as Bloomberg concludes, with continued rate hike expectations entrenched in the market, the effect of Trump’s currency war remarks could dim: “The knee-jerk reaction to Trump’s foray into monetary policy will fade rather quickly,” said BMO’s Lyngen. “The Fed will change policy when the economic reality suggests it’s time.”

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Author: Tyler Durden

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