Central bankers and finance ministers from G7 countries have formally agreed to use “all appropriate policy tools” to tackle the economic impact of the spread of the COVID-19 virus. The Federal Reserve got the ball rolling with an emergency cut of 50 bps on Tuesday while the Bank of Canada followed with a 50-bps cut of its own the day after. Even the ECB announced that it stood ready to take necessary measures to collaborate in this concerted effort. Even though these rate cuts were not part of our base-case scenario a month ago and despite the fact that there may be more to come, we find comfort in the behavior of the yield curve.
In the chart above, we can see that it’s the short/mid part of the curve that has experienced the largest drop in yields. Readers of From the Bond Desk will be familiar with our reluctance to buy 30-year bonds because of their unattractive risk/reward profile. With the recent steepening of the curve of late, one might think that we’ve softened our stance. Quite the opposite. Historically, the future prospect of rate moves is priced into 30-year bond yields earlier than in those of shorter maturities, so when central banks do take action, long-term yields don’t move as much as shorter ones – that’s what we saw this week, with 30-year and 10-year yields dropping 15 bps and 25 bps respectively. For us the yield curve has just started to steepen, and we wouldn’t be surprised to see the 30-year minus 10-year spread increase to as much as 60 bps from 30 bps it stood as of this writing.