As we noted earlier today, long-end yields on both the 10Y and 30Y Treasury have blown out in the past two days, sending the 10Y above 2.96%, the highest level since the Fed rate hike…
… which in turns has dramatically steepened the yield curve by just under 10bps, from a multi-year low just last Friday, to the steepest since the end of June.
What’s behind the move?
The answer, according to BofA, is simple: While the Fed controls the front end of the yield curve, the ECB and BOJ are in charge of the back end, or as the bank summarizes:
Front=D.C., back end=Frankfurt+Tokyo
Clearly this is a simplification as rate hikes have some impact on the back end as well as do other stories – such as the big ongoing pension reallocation trade. But as BofA notes, “consider that when the ECB recently communicated the end to QE they did so in a super-dovish way by guiding negative interest rates way into the future, which led to bull flattening in the back end of the US Treasury curve (fig 11).”
Fast forward to today, as we reported earlier, we saw the opposite effect – i.e. a meaningful bear steepening – in large part (other part was President Trump’s pushback on rate hikes) a response to news headlines suggesting that the BOJ is contemplating tweaking its QE program to steepen the back end of the JGB curve, shown in fig 12 below.
That would help financial institutions suffering in the present environment with a lack domestic yield opportunities, and has manifested in a prompt jump in global bank stocks.
One way to steepen the back end of the JGB curve would be to widen the band on 10-year JGB yields from 0-10bps presently to 0-25bps or even 0-50bps.
Incidentally, this also highlights the biggest risk to US credit spreads, i.e. that the support from super-easy foreign monetary policies declines over time. Obviously the BOJ is far from meeting its policy goal of just-shy-of-2% inflation so the impact of any monetary policy change should be limited for now. However, any serious discussions of adjusting YCC in Japan, and the biggest casualty would be not JGBs but long-bonds in the US. Alternatively, should the BOJ announce nothing next week and keeps the 10Y target range at 0-10bps, watch yields tumble and the curve pancake even more as the latest batch of Treasury shorts is steamrolled.
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