The big 2020 yield-curve steepening bet likely to fall flat

New York

IT'S been a rough start to the year for the bearish bond trader, as an abrupt escalation in US-Iran tensions has sent investors retreating to the safety of Treasuries.

Benchmark yields tumbled on Friday, driving the curve flatter, as the market digested the potential ramifications of a US airstrike that killed one of Iran's top generals. Iran's vow of retaliation, coming on top of North Korea's Jan 1 threat of "shocking" action to avenge American sanctions, puts geopolitical angst front and centre even before many investors have returned from the New Year holidays. And those anticipating cheerier news on the economic front faced disappointment from the worst US factories data since 2009.

The defensive turn is a blow to one of the past year's most tantalising trades - the curve steepener. Over the past month the move towards a wider curve looked in full swing as the US 10-year yield rose to its highest point above the two-year in more than a year. Fans of the steepener have seized on improved global manufacturing data, headway on a US-China trade deal and fledgling inflation pressures as the makings of a sustainable trend. That yield gap traded on Friday at around 26 basis points, a far cry from its inversion back in August, when recession fears gripped the market, but about 10 basis points flatter than its peak at year-end.

Friday's manufacturing figure "was just flat out not a good number", said Jim Bianco, president and founder of Bianco Research LLC. The curve can get "close to being inverted, and that's predicated on two things: One is that I don't think the data's going to come through; and two, the trend in interest rates is lower."

His call is for the curve to flatten back towards zero in the first half of this year, with the 10-year approaching its 2019 low around 1.43 per cent, compared with about 1.8 per cent now. That may well beckon a Federal Reserve rate cut in the first half of the year, in his view. Options positions betting on that sort of scenario have been popping up last week.

Developments related to Iran will probably keep markets on edge this week. The US is sending more troops to the region in the wake of the airstrike. But investors may also be distracted by what central bankers say over the weekend at an American Economic Association conference in San Diego, which will include panels featuring former Fed chair Janet Yellen and current New York Fed president John Williams, among a host of global financial officials. They may add a geopolitical angle to the risks noted in the Fed's minutes from its December meeting - released on Friday - which focused on uncertainty over international trade and weakness in economic growth abroad. BLOOMBERG