Most will know we have been advocates for US Treasury curve flattening for an extended period of time and of course the UST curve is very important as it is the benchmark off which all US dollar credit spreads are measured. Since the end of June this year, so a little over five months, the 2- to 10-year benchmark spread has tightened 36 bps and now sits at just 56 bps, while the spread between the 5- and 30-year has tightened 31 bps to just 63 bps, a dramatic flattening of the yield curve. Now we all know the story, the market is clearly not on the same page as the Federal Reserve when it comes to inflation expectations, and with the Fed tightening path; we do expect a further 25bp on the funds rate next week, which is positive for longer-dated bonds as it further reduces the risks of inflation.
However, recently the flattening of the UST curve has accelerated. Since mid-November the 2s10s spread has tightened 12 bps and the 5s30s spread has tightened 14 bps, in just three weeks. After talking to friends on a UST desk in New York it would appear there has been some added buying in longer-dated US Treasuries from corporate America. We have come to the conclusion that one element in the curve flattening acceleration of late is due to the pre-funding of pensions by corporate America ahead of the anticipated tax cuts - currently still with the lawmakers - but expected to be agreed ahead of the new year. By pre-funding pensions now, US corporates can claim the current deductible rate, however, once tax-cut legislation comes in, that deductible rate could fall. Thus, pre-funding into the long-dated UST market ahead of the tax agreement may have tax benefits for corporate America. Very interesting we hear you say.
Today is Non-Farm Payrolls day, the last release of 2017, NFP came in at 228k a little higher than expected, with the unemployment rate unchanged, at 4.1% and average hourly earnings at 0.2%; pushing the year-on-year rate to 2.5%, slightly below consensus. So, a slightly stronger headline number with only 3k two month revision and a stable participation rate at 62.7%, we believe this almost guarantees the Fed will tighten a further 25bps next week.
Have a good weekend.