USTs – Yield Curve Expected to Flatten to Fresh Lows

U.S. treasuries (10y 2.31, +5.5 bps) fell on Monday with 5-years again under-performing. Probabilities for a December hike rose to 80.2%. Strong gains across commodities continue to reflect the global growth story. However TIPS breakevens failed to follow along, narrowing 1 – 1.5 bps.

The 2-year 10-year spread is 1 bps above its flattest level in 2016 at 75 bps. A break below would confirm bond investors are preparing for a policy mistake. Our models show the neutral rate close to 125-150 bps. Another hike would tighten financial conditions for the first time in this hiking cycle.

All maturities are modestly rich to fair value: 2s 1.55, 5s 1.97, 10s 2.34, and 30s 2.86. 5 day outlooks are bearish with yields expected to rise 3-4 bps. 20 day outlooks remain flattening friendly with 78% probabilities 2-year yields RISE versus 55% 30-year yields FALL.

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