The bond trade that many of the largest banks on Wall Street believe will be dominant for the remainder of 2024 is gathering steam ahead of an inflation report that will be critical to its fate. This strategy is based on the expectation—which has recently attracted a lot of attention—that the US yield curve would adjust towards a steeper slope. The link between short- and long-term interest rates, as well as the assumption that the economy will cause these rates to diverge more considerably, are central to the idea of a steeper yield curve.
This wager received an initial boost following President Joe Biden’s debate performance on June 27, which appeared to clear a smoother path for Donald Trump’s potential return to the White House. In the wake of the debate, strategists at major banks such as Citigroup Inc., JPMorgan Chase & Co., and Morgan Stanley have promoted what’s being referred to as the “Trump trade.” The concept is that Trump’s policies, particularly those related to tariffs, immigration, and fiscal deficits, would lead investors to demand higher yields on longer-maturity Treasuries. This expectation is grounded in the assumption that such policies would increase inflationary pressures and the federal deficit, thereby pushing long-term interest rates higher.
The trade saw further encouragement on Friday when new data indicated a softening job market, which bolstered expectations that the Federal Reserve might cut interest rates this year. This development led to a sharp decline in short-dated yields. A closely watched measure of the yield curve—the gap between 5- and 30-year yields—expanded to its widest point since February following the release of this data. However, this move was partially reversed on Monday as yields rose across different maturities in London trading. The movement of the yield curve is often influenced by changes in investor sentiment and expectations about future economic conditions.
The principal driver for this steepening trade is expected to be the Federal Reserve’s easing, which puts a significant emphasis on upcoming inflation readings. According to a Bloomberg survey, consumer prices likely rose at the slowest annual pace since January in June. Evidence of further disinflation could remove a major hurdle to the success of this steepener trade, as Fed officials have been indicating that they are not yet ready to lower rates. The anticipation of a slowing inflation rate is crucial because it would signal to the Fed that the economy may need less aggressive monetary tightening, potentially leading to rate cuts that would steepen the yield curve.
Cindy Beaulieu, chief investment officer for North America at Conning, expressed optimism, stating, “The steepening because of inflation, because of fiscal policy, can continue.” This sentiment reflects a broader confidence that fiscal policy and inflation trends will support the normalization of the yield curve. Investors are closely watching fiscal policies, including government spending and tax policies, which can influence economic growth and inflation, thereby affecting the yield curve’s shape.
At the start of 2024, this trade was also a market favorite. Investors entered the year betting on a series of Fed rate cuts, but these bets were derailed by a resilient economy and persistently high inflation. As of June 27, before the debate, the difference between 5- and 30-year yields was about 5 basis points narrower relative to the end of the previous year, indicating that the trade had not yet yielded the expected returns. The resilience of the economy and the stubbornness of inflation have been key factors complicating the expected movements in the yield curve.
The upcoming consumer-price index (CPI) reading is crucial, as it will provide additional data to assess the direction of inflation and the likelihood of future Fed actions. The latest inflation data is anticipated to show a continued trend of slowing price increases, which could support the case for a steeper yield curve. This scenario would benefit the Trump trade by validating the expectation that longer-term yields will rise relative to short-term yields. The CPI data serves as a critical indicator for investors, influencing their expectations about future monetary policy and economic conditions.
If the CPI data confirms a deceleration in inflation, it could further solidify the belief that the Fed may be more inclined to cut rates, which would steepen the yield curve. This potential easing by the Fed is a critical factor for the steepener bet, and investors are closely monitoring these inflation metrics to gauge the Fed’s future actions. The interaction between inflation data and Fed policy decisions is a key dynamic driving investor behavior in the bond market.
Moreover, the political landscape, particularly the policies advocated by Trump, plays a significant role in shaping investor expectations. Policies that increase fiscal spending or disrupt trade relations could lead to higher inflation expectations and, consequently, higher long-term yields. Investors are positioning themselves accordingly, betting that these factors will contribute to the normalization of the yield curve. The intersection of politics and economic policy is a significant consideration for investors making decisions about the yield curve.
A normalization of the yield curve due to prospective Fed rate decreases and political developments is driving investor interest in the steepener trade, which is becoming more popular. As it will affect expectations regarding the Fed’s future actions, the impending inflation reading will be a critical factor in determining the trade’s success. The data may lead to a steeper yield curve, in line with major Wall Street banks’ expectations, if the data continues to support the assumption of prolonged disinflation. For investors navigating the shifting political and economic landscape of 2024, this trade is a major area of concentration.
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