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Strategists at BMO Capital Markets in New York are identifying what they describe as the macro trade of 2024: It’s the curve steepener, or the scenario in which long-term Treasury yields begin to trade above their shorter-term counterparts.
At the moment, both the benchmark 10-year rate
BX:TMUBMUSD10Y
and 30-year yield
BX:TMUBMUSD30Y
are below rates on everything from the 1-month bill
BX:TMUBMUSD01M
through the 3-year note
BX:TMUBMUSD03Y.
But expectations that the Federal Reserve will begin cutting rates in 2024 could alter that dynamic by sending shorter-term rates plummeting and steepening the Treasury curve.
The curve steepener has been a favorite of traders for years, and it went global in 2020 despite all the uncertainties unleashed by the COVID-19 pandemic. Around October of this year, some investors started to back away from the trade just as the 10-year yield was heading toward a 16-year high of 5%. Now, following Fed Chair Jerome Powell’s surprisingly dovish turn last Wednesday, the trade appears to be coming back into favor.
The type of curve-steepener trade that’s likely to prevail in 2024 is what’s known as a bull steepener, according to BMO Capital Markets strategists Ian Lyngen and Ben Jeffery. A bull steepener is a scenario in which short-term yields fall faster than long-term rates do, and could be fueled by continued expectations for the Fed to make between three and seven rate cuts of a quarter-point each in 2024.
“In the year ahead, investors across financial markets will be focused on timing the Fed’s first rate cut as Powell begins the process of gradually returning policy rates to neutral. Curve steepening will once again be the macro trade of the year; only instead of the bear steepening seen in 2023, a cyclical bull steepener will be on offer,” Lyngen and Jeffery wrote in a note on Monday.
Selecting the entry point and timing for the move “represents the most significant challenge for the trade and given the Fed’s higher-for-longer rhetoric, the eventual steepening will likely occur mid-year as opposed to the timing implied by the market’s eagerness to price in rate cuts in the first quarter,” the strategists said.
“We expect that when the Fed eventually reduces the target range, it will occur later than investors anticipate, and the first cut will be of the ‘fine tuning’ quarter-point variety,” they said, referring to the fed-funds rate target, which currently sits between 5.25% and 5.5%.
A steeper Treasury curve is generally associated with greater economic optimism by the market for the years ahead and would fit into the thinking behind Wall Street’s most crowded trade — next year’s soft landing. Already, one closely followed part of the bond market, known as the 5s30s spread, has been above zero for almost three straight months. However, more than 40 other parts of the Treasury curve remain inverted, with the spread, or differences, between shorter- and relatively longer-term rates trading negative.
On Monday, 10- and 30-year Treasury yields finished the New York session close to 3.96% and 4.07% respectively. That’s below the policy-sensitive 2-year rate, which ended at almost 4.46%. All three major stock indexes
DJIA
COMP
closed higher on the day.
