Strategists at BMO Capital Markets in New York have identified what they believe will be the macro trade of 2024: the curve steepener. This refers to a scenario where long-term Treasury yields trade above their shorter-term counterparts.

Currently, both the benchmark 10-year rate (BX:TMUBMUSD10Y) and the 30-year yield (BX:TMUBMUSD30Y) are lower than rates on shorter-term securities such as the 1-month bill (BX:TMUBMUSD01M) and the 3-year note (BX:TMUBMUSD03Y). However, expectations of rate cuts by the Federal Reserve in 2024 could change this dynamic by causing shorter-term rates to plummet and steepening the Treasury curve.

The curve steepener strategy has been favored by traders for many years, and it gained global popularity in 2020 despite the uncertainties brought about by the COVID-19 pandemic. Around October of this year, some investors started moving away from this trade just as the 10-year yield was reaching a 16-year high of 5%. However, following a surprisingly dovish turn by Fed Chair Jerome Powell last Wednesday, the trade seems to be regaining favor.

According to BMO Capital Markets strategists Ian Lyngen and Ben Jeffery, the type of curve-steepener trade likely to prevail in 2024 is known as a bull steepener. This refers to a scenario where short-term yields decrease at a faster rate than long-term rates. This could be driven by expectations that the Fed will make between three and seven quarter-point rate cuts in 2024.

The Fed's Rate Cut and the Steepening of the Treasury Curve

Investors in financial markets are eagerly anticipating the Federal Reserve's first rate cut, as Chairman Jerome Powell carries out plans to gradually return policy rates to a neutral level. According to analysts Lyngen and Jeffery, a significant macro trade for the coming year will be the steepening of the yield curve. However, unlike the bear steepening observed in 2023, a cyclical bull steepener is expected.

Timing will play a crucial role in this trade as the entry point needs to be carefully chosen. Despite the market's eagerness to price in rate cuts in the first quarter, Lyngen and Jeffery believe the eventual steepening will likely occur mid-year due to the Fed's higher-for-longer rhetoric. They anticipate that when the Fed does reduce the target range, it will happen later than expected, with the initial cut being a modest quarter-point reduction.

A steeper Treasury curve is generally associated with a more optimistic outlook for the economy in the years ahead. This aligns with the prevailing sentiment on Wall Street, which anticipates a soft landing in the coming year. One indicator of this optimism is the 5s30s spread, which has remained above zero for nearly three consecutive months. However, it's worth noting that more than 40 segments of the Treasury curve are still inverted, with negative spreads between shorter- and longer-term rates.

Treasury Yields Rise as Stock Indexes Rally

On Monday, treasury yields saw a significant increase during the New York session. The 10-year and 30-year rates reached approximately 3.96% and 4.07% respectively. On the other hand, the policy-sensitive 2-year rate ended at around 4.46%. This rise in yields coincided with a rally in the three major stock indexes - DJIA, SPX, and COMP - which all closed on a higher note during the final hour of trading.

This upward movement in treasury yields indicates a growing confidence in the market. Investors are feeling more optimistic about the economy, resulting in higher returns on government bonds. Additionally, the overall positive performance of the stock market further strengthens this sentiment.

As we move forward, it will be interesting to see how these trends develop and whether they will have a lasting impact on the financial landscape.

Leave Comment