Don’t fear the inversion, fear the steepener.
Although a bit “inside baseball” vis-à-vis the casual equity investor, that pithy maxim’s all-too-familiar in bond land.
In a nutshell, you fear the (curve) steepener because it can mean bonds are pricing a recession with twos (for example) rallying harder than 10s (for example).
Treasurys’ long-running 2s10s inversion ended in September of 2024 when the Fed cut rates by 50bps out of concern for the labor market (or in a nefarious attempt to manipulate the presidential election, to let the guy who won that election more convincingly than most thought possible tell it).
The steepener commenced and carried on in fits and starts until the curve reached wides right near 74bps. Then it settled into a sideways drift which may be on the cusp of ending in a breakout move wider.
As the figure shows, the 2s10s nearly breached the cycle-steeps this week amid a raft of discouraging US labor market updates including a lackluster read on private hiring, a wholly unfortunate account of January layoff plans, a big drop in job openings and a sudden uptick in jobless claims.
To be sure, there’s not a lot to ogle here — this isn’t high drama. Yet. For 2026, the US 2s10s is all of 3bps steeper, but as BMO’s Ian Lyngen pointed out on Friday morning, “Thursday’s price action appeared to be the long-awaited breakout, at least for the curve.”
In steepening to the brink of the cycle wides, the 2s10s tested resistance. And although that resistance “held on the first attempt,” it may not “survive further attempts,” Lyngen went on, adding that “the question remains whether supply considerations alone will drive the next leg steeper or if another downturn in the realized data will be required.”
That latter point speaks to the dual-causality in play. Anticipation of additional Fed cuts (particularly as Jerome Powell steps down as Chair in May) and any rekindled jobs scare will pressure front-end yields lower, while fiscal concerns, magnified by election-year imperatives and eventual upsizing in coupon auctions (that’s still “several” quarters away, according to the QRA, but it’s out there all the same), serve as a floor under long-end yields.
In his latest, Nomura’s Charlie McElligott spoke to both sides of the equation — and to the read-across for equity sentiment.
“The concern here is that we’re tilting to the flat portion of the Beveridge Curve, where fewer job openings correspond [to a] higher U-rate,” he wrote. “Accordingly, STIRS and the front-end of the cash curve [can] rally, while at the same time, 30-year UST yields remain pretty darn close to that ‘pucker’ level of 5.00% which is not exactly feel-good material for anything ‘risk.'”
