We continue to see a very violent steepening of the yield curve, but this one is looking different than steepening cycles of the past several decades. If we look at the last four times the 10Y/3M Treasury yield spread went negative (1989, 2000, 2006, 2019), it resulted in sharp reversals over the subsequent 12-24 months that flipped the spread to at least +200 basis points in each instance and as much as +400 basis points. What’s interesting is that in each of those instances, it was lower rates on the short end of the curve that led to the steepening. In 2023, it’s higher rates on the long end of the curve that are resulting in the steepening. In other words, this is another historical anomaly we’re seeing in the bond market right now and it’s difficult to tell what the outcome might be. When this spread has moved this high, this fast in the past, it typically achieves exit velocity and expands by several hundred basis points. If that scenario were to play out again in 2023, one of two things would need to happen - long-term rates move sharply higher or short-term rates move sharply lower. If the Fed follows through on its “higher for longer” stance for at least another 3 quarters, that means long-term rates could move sharply higher here. Again, this is an historical anomaly with no real precedent, so we have no good way of knowing what to expect. What I do know is that conditions are turning firmly negative, something that is being confirmed by the risk signals, and the data is supporting a potentially rapid slowing in economic activity. That would tend to suggest a flight to safety trade might not be too far, which would very likely be bullish for long-term Treasuries. Those are two very disparate outcomes, which demonstrates the level of volatility and risk that exists in the bond market right now.
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