Solactive U.S. Treasury Yield Curve Steepener 2-5 vs 10-30 Index: Time to Say Hello

The major risk for the US economy and the path of Fed normalization would be a continued rise in wage growth pushing inflation pressures higher and corporate profitability lower. Secondly, given the protractedly elevated level of inflation across the globe, wage growth would be much higher historically. Some economists suggest that wage growth would need to be above 7% YoY to lead to an inflation/wage spiral scenario. Having said that, the latest dot plot by the U.S. Federal Reserve is clearly more and more hawkish entailing:

• A larger deviation of Personal Consumption Expenditure inflation from its long-term target. The Fed forecasts inflation to end 2022 at 4.3% vs 2.6% last December – 2.3% higher than the long-term target (2%).
• Lower activity this year, with a sharp downgrade of its GDP forecast from 4% to 2.8%.
• Higher terminal rates, from 2.5% to 2.8%, above their long-term neutral rates (2.5%), meaning that it expects to implement a restrictive bias to curb inflation pressures.

The strategy of the Solactive U.S. Treasury Yield Curve Steepener 2-5 vs 10-30 Index consists of the longs/shorts, which places a long position in two-year and five-year US Treasury bond futures and a short position in 10-year and 30-year U.S. Treasury bond futures. To harvest further performance from the movement of the U.S. Treasury yield curve, Solactive equips the index with a multiplier leveraging on both directions the action of the yield curve by a factor of ten.

The suitability of monitoring this index reflects the shift in the Fed’s target from “financial stability” and “growth support” to “inflation fighting”. This shift is clearly visible when we see the flattening yield curve.

On Monday March 28, the U.S. 5-year and 30-year Treasury yields inverted for the first time since 2006, raising fears of a possible recession. The yield on the 5-year Treasury note rose to 2.56%, while the 30-year yield fell to 2.55%. This is the first time the shorter-dated 5-year Treasury yield has risen above that of the longer-dated 30-year U.S. government bond since 2006 — just a couple of years before the Global Financial Crisis. At its high of the session, the 5-year yield hit a high of 2.67%.

Indeed, the spread between the “dovish” and the “hawkish” camps narrowed sharply and looks tighter than in previous hiking cycles, reflecting the strong consensus among Fed members.

The minimum two-year Fed rate, reflecting the most cautious members, is now 2.4% against 3.3% for the maximum two-year Fed rate, representing the most hawkish members.