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Fixed Income Weekly: Why the US TB Curve Has Changed Direction

The author is an analyst with NH Investment & Securities. He can be reached at [email protected] – Ed.

Last week, US short and long-term TB spreads fell on discussions of: 1) FF rate hikes in 2022; 2) a BOE rate hike within the year. However, we assume that the Fed will tend to tighten gradually and that the US economy will continue to recover. Last week’s flattening of the curve should not be the start of a new trend.

Drastic fears of aggravation lead to falling term premiums

In the FOMC minutes of September, most participants rated that the condition for t -ering – a significant further advance – had already been achieved or would soon be achieved. They also suggested that t -ering should start at the end of the year and end around mid-2022. It is very likely that the FOMC meeting in November will announce the throttling.

However, we recommend focusing on the dispute over the timing of an FF rate hike rather than t -ering off. Various participants mentioned that a rate freeze over the next few years was  -propriate, but a number of members called for a rate hike by the end of 2022. As a result, Euro-Dollar futures rose to 45bps.

Discussions about possible rate hikes by the Fed and BOE led to a decrease in short and long-term US TB spreads. In other words, escalating discussions beyond the throttling dampened growth and inflation expectations, flattening the US TB curve. Reducing the spreads by 10 to 5 years and 30 to 5 years confirms this idea.

We don’t expect last week’s flattening to become a new trend. In order for a new trend to emerge, the prospect of a rate hike in the FF would have to become more tangible and there would have to be signs of a further economic slowdown. However, September retail sales took a surprise as auto and parts sales, which had declined mm for the fourth straight month, posted positive growth. The TB market is increasingly focused on economic recovery over the next year as the year draws near, and the Fed is likely to continue to separate rate cuts and FF rate hikes. The economic recovery and gradual tightening should stimulate long-term TB yields on an upward trend.

KTB curves in a different way

After the MPC meeting in October, the futures markets are pricing in rate hikes of 93 basis points for the next 12 months, as the BOK governor hinted at the possibility of several upcoming rate hikes and stated that 2022 could offer favorable conditions for rate hikes.

As concerns emerged recently about drastic rate hikes, TB curves flattened in major DM countries, while long-term yields rose in Korea. This is due to the expectation that the economic recovery of the DM will spill over to Korea. However, the recovery of DM economies will focus on service consumption rather than goods, which poses a risk to domestic exports as semiconductor exports are likely to slow. We note that 10-year to 3-year KTB spreads are currently peaking in 2017 from the previous major Semicon cycle. We expect the KTB curve to flatten out.

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