The US yield curve has steepened sharply as investors weigh the prospects of a Democratic victory in the upcoming US election and the potential of more aggressive fiscal policy.
On Tuesday, the yield on five-year Treasury notes traded 127 basis points below that of 30-year government bonds — the widest gap since 2016, save for a brief intraday move in June — after investors ditched ultra-long securities at a faster pace than their shorter-term counterparts.
The yield on 30-year Treasuries has risen 0.14 percentage points since the start of the month to 1.6 per cent, while the benchmark 10-year yield has climbed 0.1 percentage points to 0.78 per cent.
Shorter-dated Treasuries have barely budged, however, with two-year yields steady at 0.14 per cent and five-year notes at 0.33 per cent.
Investors said the back-up in longer-dated Treasury yields was driven in part by the growing chance that the November 3 election could result in a “blue wave” whereby the Democrats clinch the presidency and both chambers of Congress.
This is likely to pave the way for more ambitious relief packages to support the fledgling US economy and more Treasury securities flooding the market to fund it, they said.
“A blue wave means more supply and therefore higher rates,” said Priya Misra, global head of rates strategy at TD Securities. “People realise that the Democrats are more in favour of bigger fiscal stimulus.”
Negotiations for another aid programme have stretched on for months, following the July expiry of critical benefits for Americans hardest-hit by the coronavirus-induced economic slide. Democrats have twice passed large relief bills in the House of Representatives but the plans have not been matched in the Republican-controlled Senate.
Steven Mnuchin, Treasury secretary, has sought to broker a deal ahead of the election, so far without success, although talks were continuing on Tuesday.
“It will be much easier to get fiscal stimulus through if there is a majority in both the Senate and the House and the presidency for Democrats,” said Kathy Jones, chief fixed-income strategist at Charles Schwab.
Last week, modelling of poll data by FiveThirtyEight showed that Democrats had a 61 per cent chance of winning the Senate. That has since risen to 66 per cent.
Federal Reserve policy has also played a critical role in the steepening of the yield curve, strategists said. The US central bank is currently buying $80bn of Treasury securities per month, across a range of maturities.
Investors have called on the Fed to tilt its purchases to longer-dated notes, given that the Treasury has ramped up issuance of this kind of debt. Without a firm commitment to do so, investors warn long-term bond yields will continue to feel upward pressure.
“What happens to the 10-year is dependent on what the Fed does,” said Ms Misra. “They are the marginal buyer.”
Jay Powell, the Federal chair, has told US policymakers that providing too little support for the American economy would be far more dangerous than offering excessive help. In an appearance on Tuesday, he stepped up his calls for a new stimulus package, saying the economic recovery from the damage inflicted by the coronavirus was “far from complete”.
Ms Jones said the recent steepening of the yield curve also reflected improving expectations for the US economy — especially if more robust government support is in the offing. While labour market improvements have begun to stall, fears about a double-dip recession or a much more pronounced deflationary spiral have been kept at bay.
“It reflects more optimism about the future,” she said.