Well Citi has seen enough.
In an amusingly understated new piece the bank explains why “curve steepening will go nuclear.” That’s a real quote.
See previously, the bank was ok with playing for a steepening of the 10s/30s curve on the back of expectations for a supply glut tied to Trumpian fiscal stimulus. Citi was “cautious” on that trade recommending 1X2 curve floor spreads that would only turn to sh*t if the 10s/30s swap curve inverted.
Well now, it’s time to “go nuclear” with an outright cash steepener in 5s/30s and can you guess what the rationale is? That’s right: heightened geopolitical and policy risk tied to Trump, which makes you wonder if maybe there was a double entendre in Citi’s title.
Earlier this week, we added a 5s30s cash steepener to the research portfolio. The flatness of the 5s30s curve strikes us a temporary anomaly that should slowly correct as the notion of an aggressive Fed is replaced by that of a risk averse Fed. While we had earlier cautiously positioned for steepening via curve options which gave us a payoff as long as 10s30s did not invert, we are now much more willing to position aggressively for a steeper curve, given how flat the curve looks. We are using 5s30s as our preferred way of playing for a steeper curve – the residual to our model is at the highest level in quite some time. The original rationale for a steeper curve was higher Treasury supply with increasing deficits. Now, a re-examination of the path of short rates provides another boost to the curve.
The curve steepening can gain substantial momentum if political risks rise — in our view, these risks are rising with the new administration redrawing geopolitical alliances for example. It is possible that the White House may draw down just enough capital from the Republican party such that the passage of fiscal reform starts to look like less certain, not just with the Democrats but also with fiscal hawks within the Republican party potentially holding out. For example, two Republican senators have decided to vote against the White House nominee for education secretary Betsy DeVos – while not a deal breaker because of Mike Pence’s deciding vote, it demonstrates the potential for a fallout in the more important budget and tax negotiations later this year.