Ten-year Treasuries may outperform shorter-dated maturities in coming weeks, flattening parts of the yield curve, after yields on the benchmark notes jumped substantially in this week's selloff. Treasury prices fell in volatile trade across the curve after the announcement of a deal by President Barack Obama and Republicans to extend federal tax cuts and introduce new payroll tax cuts.
A massive liquidation drove 10-year yields to their biggest two-day rise in more than two years. After underperforming other maturities, 10-year note yields may retrace some of their excess losses relative to shorter-dated debt, which would flatten the yield curve.
"We have seen the belly of the curve cheapen up significantly from very rich levels a few weeks ago," said Richard Bryant, head of Treasury trading at MF Global Securities in New York. Technical analysts at Credit Suisse predict the gap between two-year and ten-year note yields may close, after widening through key technical levels at 255 basis points during this week's selloff. This level was the 61.8 percent retracement of the 2010 flattening, the analysts said in a report.
The analysts see stronger resistance now at around 269 basis points and recommend placing flattening trades at around this level, which would benefit from the gap between the levels declining. The gap traded at around 266 basis points on Friday. Ten-year notes traded at yields of 3.29 percent on Friday, while two-year notes traded with yields of 0.63 percent. Analysts blamed a host of factors for the violent sell-off including investors pricing in revised growth forecast, concerns over the fiscal health of the United States, and $66 billion in longer-dated Treasury supply.
The unwind of long positions taken ahead of the Fed's announcement of the program on November 3 added to weakness. "I think there's been some unwinds of trades that were long the belly and I think hedge funds have exited steepening trades," said MF Global's Bryant.
"Now the question is whether there is any room to take back some of the weakness or is this where yields on the curve are supposed to be, with the Fed a month or two into their asset program and the data starting to turn the corner," he said.
The Federal Reserve will purchase about $105 billion of Treasuries and Treasury inflation-protected securities in 18 operations from December 13 through January 11 as part of its $600 billion bond purchase program that it has said will continue through mid-2011. The rapid sell off in 10-year notes, meanwhile, reduced the yield gap between the notes and 30-year bonds, and flattening in this part of the yield curve may continue, the Credit Suisse analysts said. The gap between 10-year and 30-year Treasury yields has fallen to 112 basis points from 130 basis points a week ago.
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