The liquidity slump and the yield curve

Who Stole Liquidity? The Outlook For US Treasuries

 

This report takes a ‘liquidity view’ of the US yield curve and rates. Although Global Liquidity growth is tanking at a worryingly rapid rate, bond market flows look to be more in balance. We do not expect the US Treasury yield curve to invert and it is more likely to gently steepen from around current levels. Yield curve movements depend both on term premia (largely via the long-end) and rate expectations (largely via the front-end). Aggressive rate expectations could drop back, but the low prevailing level of policy rates means it is unlikely they can fall by much. More likely is rising term premia from their unusually depressed levels. Two factors driving term premia higher are: (1) growing supply of US debt and (2) diminishing appetite for US assets from foreigners. According to a ‘liquidity view’, the ‘long-end drives the short-end’ and not vice versa. This will mean two more Fed policy rate increases. US 10-year bonds are likely to drift modestly higher, trading in a 3-3.5% yield range over the next 12-18 months, with the 10-1 year yield curve inflecting upwards from later this year.