Last week there was a very important development in bond markets: the bear steepening of yield curves!
That happens when rates move higher but it’s long-dated yields that take the lead, hence shifting the entire curve higher but also steeper.
How to interpret such a move?
Think of 10-year yields like a strip of all future Fed Funds for the next 10 years, discounted to today. This will help you follow the rationale.
Last week markets priced in a mildly higher terminal rate at 5.45% by September and pushed the December 2024 expected Fed Funds at 4.25% – effectively getting more and more in line with the Fed’s Dot Plot.
But while in the past that meant more cuts would be priced in immediately after, the bear steepening move implies that markets believe the economy can handle higher rates for much longer (red arrow).
Bear steepening regimes cause long-dated yields to rise, and this has a large and rapid tightening effect on the real economy: 30-year mortgage rates and corporate borrowing rates rise rapidly across the curve, financing becomes even tougher and negative mark-to-market effects (see regional banks) are amplified.
This is why in all three recent cases (Sep-Nov 2000, May-Jun 2007 and Sep-Nov 2018) rapid late-cycle bear steepening moves marked the end of the ‘’this time is different’’ experiment and ended up causing severe distress to economies (2001-2008) or markets (Q42018).
Will this time be different?
Certaintly these are expensive words to use in markets.
