10Y US treasury yields fell by 12bps on the first trading day of 2023, closing at 3.75%. We reckon that the fall in energy prices and soft risk sentiment (weaker equities and stronger USD) probably contributed to the rally in longer-term USTs. Concerns on the USD rates space remain the same as late last year, but we note that the curve has become less inverted. The 2Y/10Y inversion was exceedingly stretched at -80bps and this has since rebounded to -62bps (the high in December registered at -48bps). The neutral should be around -40bps, with scope for a move towards par when the US labour market (which appears immune to the tightening delivered thus far) takes a turn for the worse. Another NFP reading is due this Friday.
Our view for UST curve steepening through 2023 has not changed and we see -70bps as an interesting level to add steepeners in the 2Y/10Y segment. There are two additional drivers for DM and US curve steepening. First, the Bank of Japan (BOJ) widened the YCC band, allowing 10Y yields to reach a ceiling of 0.5% (compared to 0.25% previously). The BOJ was adamant that policy settings would not change, but clearly the string of elevated CPI proved that overly loose monetary policy might not be tenable. We had flagged this as a risk for 2023, but it has already occurred, with another band widening possible in 2Q. Steepening in the JGB curve would place upward pressures on longer-term DM rates in general. Second, China's reopening is taking place much faster than anticipated. Similarly, China's reopening would provide a boost to global growth (around mid-2023) at a time when the developed world is slowing. If the reopening takes place faster, pessimism on the global growth could lift somewhat, steepening DM curves in the process. Levels wise, we are neutral when 10Y yields are close to 3.9% (our near-term forecast) and will be biased to receive if yields push towards 4%. We prefer to receive on spikes (closer to 4.6%) for 2Y yields, noting that the market is already pricing in a terminal rate of 5% (in line with our view).
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