US curve flattening goes on and will likely continue - Danske Bank

Analysts from Danske Bank believe the factors that have driven the flattening, including expected market pricing of more Federal Reserve hikes in 2018, in a low inflation environment will continue to flatten the US yield curve over the next couple of quarters.

Key Quotes: 

“The big theme in the US fixed income market is the flattening of the yield curve where long yields have dropped, despite rate hikes by the Fed. This week the spread between 2Y and 10Y bonds reached 58bp, the lowest level in 10 years. We have to go back to 2007, when Fed Funds were 5.25% and the Fed was about to start an easing cycle to see a narrower spread.”

“The flattening in 2017 is reminiscent of the 2004-06 experience when the Fed hiked 17 times and the curve still flattened by 250bp. This development was famously named the ‘bond yield conundrum’ by Federal Reserve Chairman Greenspan in his February 16 2005 testimony, as he rejected a variety of possible explanations such as a savings glut in Asia, lower inflation expectations and a weaker growth outlook.”

“The flattening of the US curve 2y10y has been remarkable so far in 2017. We believe the factors that have driven the flattening, including expected market pricing of more Fed hikes in 2018, in a low inflation environment will continue to flatten the US curve over the next couple of quarters. Even as the curve continues to flatten we expect foreign demand to stay intact for now.”