US treasury curve continued to flatten

Arne Lohmann Rasmussen Danske Bank A/S

Market movers today

It is a fairly quiet week on the economic release front , with minutes from the latest Fed (Wednesday) and ECB meeting (Thursday) in focus together with the preliminary PMIs for the eurozone and US on Thursday and Friday, respectively.
This also means that today, October exports in Japan are the only realimportant data release. Exports came out strong in Q3 and are still the main growth driver in Japan. As long as domestic demand refuses to pick up, exports are key to maintaining the economic upturn.
In addition, ECB board members, Sabine Lautenschlaeger and Mario Draghi, are due to speak in the afternoon but we do not expect any significant new signals.

Selected market news

Late Sunday night , Chancellor Merkel’s attempt to form a new government in Germany collapsed as the FDP walked out of the so-called Jamaica negotiations. It is unclear what will happen now and whet her Merkel will try to form a minority government, a new ‘grand coalit ion’ with the SPD or if the result will be a re-election. For now, ‘polit ical uncert ainty’ has returned to Europe. Overnight , the euro has been under pressure and EUR/USD has dropped to 1.1733.

It has also reinforced the negative risk sent iment and the Asian equity markets have followed the US markets lower, where major indices ended the day down between 0.2% and 0.4%. The US market was under pressure despite good news from the housing market as both housing starts and new housing permits jumped in October. The market is st ill in profit -taking mood and it is reluctant to buy into the tax reform, as the market is st ill not convinced that it will not be watered down.

The market also took its que from the fixed income market , where the US treasury curve cont inued to flatten. The spread between 2Y and 10Y bonds is now at 62bp – the tightest level since 2007. Remember that contrary to today, the Fed was in the middle of an easing cycle in 2017.

The persistent flattening of the yield curve in the US has raised concerns that the market is preparing for a new economic downturn and that the Fed might be ahead of the curve. We do not share the view that the Fed is ahead of the curve and st ill see more rate hikes in 2018. Importantly, the flattening of the curve also reflect s global demand for ‘high yielding durat ion’ which can only be found in the US, given the QE in Europe and the zero target for the 10Y yield in Japan. The ‘low’ 10Y yield in the US furthermore reflects the ongoing debate regarding the neut ral rate being lower than assumed just a few years ago. We would not be surprised to see a further flat tening of the curve over the next couple of months.

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Arne Lohmann Rasmussen

Danske Bank A/S

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