The Steeper Curve Was Fun While It Lasted

Where We Stand – The positive sloping yield curve – it was fun while it lasted.

Well, that fun only lasted a grand total of 19 days, with the 2s10s having steepened into positive territory in the aftermath of the Fed’s 50bp cut last month, and having flattened (briefly) sub-zero once again yesterday, as fallout from Friday’s solid US jobs report continued.

Treasuries continued to sell-off across the curve as the trading week got underway, with both the 2- and 10-year yields rising north of 4% for the first time since August. A continued hawkish repricing of policy expectations on the back of Friday’s figures was the primary reason for the continued selling pressure across the Treasury complex, with the USD OIS curve now pricing just a three-in-four chance of even a 25bp cut at the November FOMC, while also pricing just 43bp of easing by the end of the year.

There are two observations that I would make on this repricing.

The first is that, having spent a while harping on about how market pricing for the FOMC, and other G10 central banks, was too dovish, I’d now argue that we have flipped to the other extreme, with the curve now discounting too hawkish a near-term rate path. One solid jobs report is highly unlikely to materially alter the FOMC’s thinking, particularly when Powell & Co have outlined a relatively clear reaction function – a cadence of 25bp cuts at every meeting, with larger 50bp moves on the table were the labour market to soften materially. I see little reason for that to have changed, and continue to expect a 25bp cut at both the November and December FOMC meetings.

Secondly, it’s worth bearing in mind that market participants have had a woeful track record of forecasting the path for the fed funds rate all year. In a game akin to ‘pin the tail on the donkey’, the OIS curve has priced a December 2024 fed funds rate as low as 3.5% - 3.75%, to as high as 5.0% - 5.25%. To think that participants will be spot on with their guesswork this time around feels like a stretch to me.

In any case, it was interesting to see the greenback trade broadly flat yesterday, and not tag along with the continued move higher in yields. This likely owes more to exhaustion than anything else, with the buck having rallied on each of the last five days in a row, and rather running out of reasons to rally further.

Still, simmering geopolitical tensions kept the dollar underpinned, with other G10s failing to make much by way of significant headway, and the high-beta AUD and NZD continuing to slump; the Swissie and the yen, though, were both well-bid, a sign of haven demand playing its part in yesterday’s market dynamic. Stocks also ended the day in the red, with the S&P and Nasdaq falling around 1% apiece, giving up the bulk of Friday’s gains, as the start of Q3 earnings season looms on Friday.

Crude, of course, continues to price a significant geopolitical risk premium as a result of the aforementioned tensions, with both Brent and WTI rallying once again yesterday, as the former reclaimed $80bbl for the first time since August. Few would seek to play crude from the short side here, with oil bears likely now in hibernation until Middle East tensions recede somewhat from their currently incredibly elevated level.

On the note of shaky sentiment, though, gold is still of interest, with the yellow metal having traded in rather heavy fashion for a week or so now. In contrast to equities, where the natural path of least resistance leads higher, and stocks must find a reason to sell-off, gold has typically proved an asset that needs a reason to rally, and where the path of least resistance leads either sideways, or lower. In that respect, gold appears to be sitting on relatively shaky foundations, raising the potential for a sizeable pullback, particularly if recent longs begin to bail out.

Look Ahead – Another quiet data docket awaits today with, frankly, nothing of much interest on it.

No top-tier economic releases are due, while three speakers from each of the FOMC and the ECB are unlikely to add especially much to the overall debate. 3-year supply is, however, due from the US, though the bigger test in this respect will come from the 10- and 30-year auctions on Wednesday and Thursday respectively.