By Robin Marshall, director, fixed income research
US sovereign spreads have proved directional since the GFC…
A key feature of recent economic and interest rate cycles has been the cyclicality and directional moves of US Treasury spreads, and the yield curve versus other government bond markets. Ever since the GFC, US yields have tended to rise more than in other markets as bond markets moved to discount the economic upswings and the expectation of the Fed tightening monetary policy. Thus, as Chart 1 shows, US 7-10 year yields rose considerably more than Bund, gilt and JGB yields both in the taper tantrum in 2013, and again in the period from 2015-18, when the US Federal Reserve raised policy rates from 0-0.25% to 2.25-2.5% in Q4 2018. In contrast, when bond yields have fallen, US Treasury yields have fallen much more than those in other markets. This was evident during the period of Fed easing in 2019-20, when US Treasury yields collapsed to a low of 0.5% in the 10-year area, in July 2020.
More recently, Chart 1 also shows US Treasury spreads began to widen more sharply again in Q4 2020, as positive news emerged on COVID-19 vaccine trials, hopes for a larger US fiscal reflation emerged (after Joe Biden was elected US president), and 10-year Treasury yields backed up more than other markets as a result.
...as yields have anticipated cyclical turning points before central banks
The directionality of US spreads is confirmed in Chart 2, which shows how 7-10yr yields fell faster in US Treasuries, relative to other markets in 2018/19 and how they have risen faster in 2020, as markets begin to anticipate a recovery from COVID-19. The decline in 7-10yr yields has often been a late-cycle signal of slowing growth, falling inflation and pending recession, as the market anticipates Fed easing. This was so in 2018/19, in advance of the 2020 recession and aggressive central bank easing in the G7 (and also proved the case in 2008/09 before GFC). In contrast, an early rise in 7-10yr yields has often been an early signal of economic recovery, accompanied by a recovery in inflation breakevens and expectations.
US yield curve has also proved more unstable than other markets
Finally, given the higher volatility of US 7-10 year yields relative to other G7 bond markets, it is perhaps unsurprising to find that the US yield curve has tended to steepen more in anticipation of a COVID-19 recovery relative to other markets, and vice versa. This effect may now be compounded by yield curve control in Japan. Curve control has been successful in holding JGB 10-year yields at zero, and confining any steepening in the JGB curve to about 10bp, and strong forward rate guidance from the ECB that policy rates will not rise for some years. This is shown in Chart 3,which shows how flat yield curves have remained in both Germany and Japan, in contrast to the US particularly.
Quantitative easing may well be distorting the economic signaling from these yield and curve moves. However, this did not prevent US yields and curves giving a strong signal in advance of the 2020 recession.
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