Friday and Monday’s 10bps cumulative bear steepening of the Treasury curve highlights the extreme sensitivity in the rates market to the degree of foreign monetary policy accommodation.
As BofA notes, all it took was speculation in the press that the BOJ is contemplating policy adjustments to engineer higher interest rates in the back end of the JGB curve (in order to aid financial institutions), and global bond yields erupted higher (and bond futures prices lower in Japan, Germany, and US).
BofA points out that it also shows that foreign central banks exert material influence on the back end of the US rates curve (along with the Fed, the pension reallocation trade, etc.).
The big immediate risk to US fixed income is a much bigger bear steepener in global rates, which could lead to large outflows, disorderly conditions and much wider credit spreads.
Such steepener would be a real, undistorted, signal of the possibility of near-term pain, in contrast with consensus concerns about the possibility of an inverted yield curve – which is a distorted (by foreign monetary policies, etc.) signal of recession much further down the road in 2-3 years.
However, BofA says it is “not too concerned”, because in this particular case, the BOJ continues to fail materially in meeting its policy goal of just shy of 2% inflation.
In fact, BofA even has a silver lining, suggesting that a moderate bear steepening with the BOJ’s situation relatively unchanged (and thus vol likely to remain relatively low) should stimulate yield-sensitive corporate bond buying – especially in the back end of the curve – and help fuel further recent spread curve flattening.
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