CURVE STEEPENERS ?
In macro circles, it has become popular to talk about potential US curve "steepener" trades. This piece looks at what asset markets have historically done when the US yield curve (10y -2y) hits its most negative/flat point and starts to steepen.
On average, once the inflection point in the curve is reached, 2y yields are off close to 150bps on a median basis within 6m, which looks extraordinarily sharp at this point, but not when placed in the context of recent events. The 10y tends to decline by roughly half the move in 2year yields over a 6m and 12m time horizon.
We believe the Fed tends to cut 2 X as fast as the distance travelled during the hiking cycle.
Among the most vital signals is that the curve inflection point has presaged significantly stronger equities in the year ahead and that any risk appetite negativity has been concentrated in credit markets and a widening in credit spreads. This is consistent with equities leading the business cycle, and credit spreads lagging behind the cycle.
Twelve months after a curve inflection has been reached, the S&P is up by a median of 13.2% and was up in 6 of 7 rate cycles. BAA - 10y yields have tended to be wider in 6 out of 7 cycles 6 months after the inflection point.
Regarding FX signals, as per the Tables below, the USD tends to weaken against the EUR, and this signal is pretty consistent over the longer-term (2 years). This USD weakness is not evident in the Aussie or yen. FX signals are generally less consistent, as shown by the relatively lower 'hit ratios.'
Gold typically trades well as the curve inversion reverses and the curve steepens. Gold strength in these circumstances has been most evident in the last couple of cycles when the rate cuts were particularly sharp, and ZIRP with QE came more quickly into focus.
Oil also shows a significant upside bias after the curve inflection point, consistent with a recovery signal as the curve shifts more positively.
On the vol side, Bond vol decreased a couple of years sharply after the curve tended to steepen, except in 2008 when vol exploded.
On FX vol, the medians show, if anything, some increase in realized G10 FX vol, and the charts below show, that two of the last five cycles have also seen brief episodic spikes in realized (CVIX3R) FX vol consistent with an unstable macro landscape that often typifies the transition to a steeper curve.
"Hit ratios" by instruments - how often the response for 12 months after inflection is consistent with the median reaction.
( Deutsche Bank)
