The recent rout in Treasury bonds, which has caused turbulence in the stock market and sparked recession concerns in the U.S., paused on Monday as long-dated Treasury yields experienced their largest pullback since March.
However, some experts on Wall Street believe that the “bear-steepening” trade in Treasurys may have gone too far. George Saravelos of Deutsche Bank observed in a commentary that the yield curve has been steepening for five consecutive weeks, the longest streak in two decades.
In a bear steepening scenario, yields on long-dated Treasurys rise more rapidly than yields on short-dated bonds as investors sell off bonds. This is due to the inverse relationship between bond yields and prices, where yields increase as prices decline.
Saravelos noted that the current bear-steepening trend is already the most enduring in at least two decades, and there is a possibility that it could transition into a different regime.
According to Saravelos, there are two potential scenarios for this regime shift. The Federal Reserve could choose to raise interest rates even higher than previously indicated in their September projections. This would likely result in short-term rates increasing faster than long-term rates, as observed in the Treasury market in 2022 when the Fed rapidly raised interest rates at a pace comparable to the 1980s.
Alternatively, the Fed could decide to halt future rate hikes and signal a reconsideration of maintaining higher interest rates for a longer period. Several senior Fed officials have already suggested that rising Treasury yields might enable the Fed to adopt a less aggressive stance.
On Monday, Dallas Fed President Lorie Logan echoed this sentiment by stating that the rise in long-term Treasury yields and the subsequent tightening of financial conditions could reduce the need for the Fed to further raise interest rates.
On Tuesday, the yield on the 10-year Treasury declined by 12.9 basis points to 4.654%, representing its largest one-day yield decline since August 23, based on yields at 3 p.m. Eastern time.