Up to an $800 billion negative shift in the demand-supply balance for US Treasuries – could the US yield curve actually steepen?
9th June 2017
Historically, in periods of monetary policy tightening by the US Federal Reserve (Fed), the US yield curve has flattened and eventually inverted as shorter-dated US Treasury yields rise more than longer-dated Treasury yields.
This flattening and then inversion of the yield curve has always led to recessions as banks curtail lending to the real economy due to shrinking net interest margins; banks make money by borrowing short and lending long-term. This phenomenon causes a contraction in the extension of credit and slows the economy.
Question: What factors will distinguish the current Fed hiking phase from previous policy cycles?
Answer: Fiscal stimulus (tax cuts and infrastructure spending) combined with an unwinding of the $4.5 trillion US Fed Balance Sheet should steepen the curve, and may perpetuate the economic cycle.
Question: Why should yields rise and the curve steepen?
Answer: Less demand and more supply.
Up to an $800 billion shift in the demand-supply balance for US Treasury Bonds caused by
1. A shift in net demand due to the Fed ceasing purchases (Quantitative Easing) and not re-investing maturing bonds.
2. A greater supply of longer-dated US Treasuries to pay for US infrastructure programmes.
The author is of the view that the Federal Reserve is likely to stay behind the curve in the medium-term with regards to policy rate hikes – shorter-dated Treasuries should remain supported. Also, the potential for a sizeable fiscal stimulus package from the Trump administration is being underestimated by the market. The reflation theme evident across the global markets since the summer of 2016 remains broadly intact.
Sam Hogg and Brian Tomlinson
Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.
Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.
This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations. The information contained herein is confidential. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.