The Wall Street Journal-20080114-Bets on Yield Gap May Be Hot
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Bets on Yield Gap May Be Hot
Betting on a widening gap between the two-year and 10-year Treasury- note yields may be the most profitable trade this week.
Two-year notes, the most sensitive to expected changes in central- bank policy, will continue to beat their peers in the 10-year sector. That would cause the benchmark yield curve, already at its widest in three years, to steepen further. Barclays Capital, Credit Suisse, Royal Bank of Scotland and Bank of America all recommend that investors get on board for the trade.
The gap widened Friday to levels last seen in 2004 as fear of a recession deepened, triggering expectations of aggressive interest- rate cuts by the Federal Reserve. Investors piled into short-dated government debt, sending the two-year yield down more than 0.11 percentage point to 2.591%. Longer-dated maturities lagged behind amid some concerns about inflation.
This week's data calendar could add fuel to the curve-steepening fire. December's retail-sales figure will garner particular attention.
"The economy is sinking, and it is sinking faster than the Street and the Fed think," said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading in New York at Deutsche Bank AG's private wealth-management unit. "The Fed has to cut interest rates more aggressively. I think a steepening yield curve still has a way to go."
He predicted the benchmark yield curve will steepen a quarter percentage point over the next month and another half percentage point by the end of the first quarter. Late Friday, the gap, as measured between the two-year and 10-year yield, stood at 1.217 percentage points.
While the two-year notes benefit from Fed rate-cut buzz, 10-year notes and 30-year bonds may lag behind because longer-term debt is more sensitive to inflation risks.
