Treasuries outlook: US yield curve steepens; junk sector stabilises

US Treasury yields rose on Friday, steepening the yield curve, as traders closed out some curve-flattener positions and dealers reduced their holdings of longer-dated debt following this week's auctions. Dealers sold their purchases from the $23 billion 10-year and $15 billion 30-year auctions this week, which were part of the government's $64 billion quarterly refunding, analysts said.
Curve flatteners, in which traders favour longer-dated issues over shorter-dated ones, have made longer-maturity Treasuries expensive. The sell-offs in junk bonds and stocks have raised concerns about stretched valuation across asset classes given their impressive gains this year, traders and analysts said. The curve move coincided with some stabilization in the junk bond sector, which had been battered in recent days, partly on worries about a delay in US federal tax cuts. Yield spreads between short- and longer-dated Treasuries grew to their widest in a week.
"It's a reversal of the recent flattening and repositioning along the curve," said Mike Lorizio, head of Treasuries trading at Manulife Asset Management in Boston. The two biggest US-listed junk bond exchange-traded funds by assets rose from seven-month lows hit on Thursday. Still, they posted their biggest weekly loss in three months. The three major US stock indexes were flat to 0.1 percent lower on the day, off initial lows.
The 10-year Treasury yield reached a 1-1/2 week peak of 2.405 percent, after hitting a near three-week trough of 2.304 percent two days earlier. The two-year yield reached a nine-year high of 1.662 percent. The yield spread between two-year and 10-year Treasuries widened to 74.0 basis points from a decade-tight level of 65.9 basis points on Thursday, Reuters data showed.
Traders had favored curve flatteners the past two weeks on concerns about the tax overhaul and a diminished likelihood of an introduction of a Treasury bond that matures beyond 30 years. Other factors were expectations that the Federal Reserve would hike rates further and domestic inflation remaining below the Fed's 2 percent goal.
The Treasuries sell-off was exacerbated early on Friday by a drop in German government debt prices, following perceived hawkish rhetoric from European Central Bank Council member Ewald Nowotny. Nowotny said the ECB should have given a clear signal at its policy meeting last month about ending its 2.55 trillion bond purchase program in September 2018 if the euro zone economy improves further.