(Bloomberg) - Longer-dated US Treasuries weakened Thursday, propelling the yield curve to steepen to a level last seen about 30 months following the Federal Reserve’s hawkish interest-rate easing and projections for fewer rate cuts next year.
The two-year yield was lower by 4 basis points to 4.31%, while the 10-year rose some 8 basis points to a session high of 4.59%, and was trading around the highest level since late May. That divergence in yields saw the two-year trade as much as 0.27 percentage points below the 10-year — a level previously seen in June 2022, with the yield curve steeper by some 11 basis points on the session.
The so-called steepening has been driven by a reticence among investors to own longer-dated Treasuries given sticky inflation and a resilient economy after the Fed has cut policy rates by 1 full percentage point in recent months.
“The weakness in the longer-end of the curve can be credited to a combination of the Fed’s hawkishness, ongoing supply angst, and a collective unwillingness to step in front of the decisive price action,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets. He said the trend of a steeper curve “still has a meaningful distance to travel before the end of 2024.”
Bond investors are also mindful of the potential for tax policies advocated by President-elect Donald Trump — who takes office next month — to fuel both growth and inflation, and also worsen an already large budget deficit.
The benchmark 10-year note’s yield surged above 4.5% on Wednesday after the Fed indicated a pause was likely in the cutting cycle early next year and officials saw only two quarter-point rate cuts for all of 2025, given the lack of progress in bringing inflation down to their 2% target.
Reticence for Treasuries beyond the front end also extended to the inflation market. A $22 billion sale of five-year Treasury inflation protected securities at 1pm in New York attracted weak demand from non-dealers. The auction cleared at 2.121%, up sharply from a level of 2.05% leading into the bidding deadline.
In the aftermath of the Fed meeting, some traders turned their attention to the prospect of the central bank commencing a rate-hike cycle at some point next year. Action in the options market linked to the Secured Overnight Financing Rate included a couple of large trades over the Wednesday session, supporting a sharp hawkish pivot by the end of 2025. Open interest released Thursday signaled trades were taking on new risk.
The latest losses in the 10-year Treasury built on a steady losing streak that has driven its yield up from a low of 3.60% in mid-September. In that time, the 2s10s yield curve has turned positive after a prolonged period of inversion.
Asset managers who in general prefer owning short-dated bonds, given the uncertainties around the outlook for deficits, Fed rate cuts and what policies the Trump administration will ultimately get passed through Congress next year, also provide a tailwind for the yield-curve steepening.
“Where the front to the belly of the curve is settling, is probably a place that we are comfortable owning duration and staying a little more skeptical out the curve just given the policy uncertainty about next year,” said Russell Brownback, portfolio manager at BlackRock.
The trend of preferring the short-end at the expense of the 10- and 30-year yields Thursday was maintained after data showed a slightly higher-than-expected upward revision to economic growth in the third quarter and after weekly initial jobless claims were weaker than forecast.
The preferred inflation gauge that the Fed is trying to bring back down to a long-term average of 2% increased to 2.3% in October. The November reading, due to be released Friday, is expected to be 2.5%, with an increase to 2.9% for core prices.
By Michael Mackenzie
With assistance from Edward Bolingbroke
