Treasury yield curve dynamics - It does not require large yield changes to have a big move

 

The yield curve as measured by the 10-year minus 2-year Treasury spread has seen a significant reversal from the big reflation trade to a flattening move under the expectation of a Fed who will push policy action slightly forward (six months) and will be conduct more normalized behavior to tame inflation. There is also a view that inflation is transitory, and we have reached peak growth. Whether these themes continue is subject to debate and will dominate the fixed income narrative.  

Before significant judgments are made on what is the correct curve moves, there needs to be some historical context. The one-week changes in the 10-2 spread are not at extremes. What is at extremes are the combination of one week changes across the last 4- and 8-weeks. As a measure of extreme, we calculated the 4- and 8-week changes since 1976 and gave each a percentile rank. We used percentile measures given the non-normality of curve changes which have very fat tails. Earlier this year, we have had some of the largest curve steepening by rank for both 4- and 8-week periods. In the last few weeks, that extreme has completely reversed. We now have some of the greatest flattening moves. What is clear is that fixed income sentiment has moved from a reflation extreme to a possible "peak growth" extreme. 

However, these switches between extremes are not unusual and the size of the 10-2 spread move to be in an extreme are actually quite small. For example, the 36-bps flattening over the last two months (July 12, 2021) places it in the 7th percentile while a 50-bps steepener is in the 95th percentile of moves and occurred in early April 2021. It does not take much to reach what would be called big moves in the curve trades. 

Nevertheless, investors should remember that yield curve trades can bounce between extremes in the short run (inside two months) but have very long-term trends based on long-term monetary policy.