US rates: Three cheers for the flattener – TDS

Analysts at TDS explain that the US rates market reacted dovishly to Yellen’s last FOMC press conference as the Fed suggested little impact of the tax plan on growth, inflation or interest rates.

Key Quotes

“Even though the curve bull steepened after the meeting, given that the market is still pricing in only 2 hikes in 2018, we think that there is still some more room to flatten. However, we recommend hedging the directionality of the trade via 2m5y receiver spreads.”

“The Conference Committee initially hit some road blocks on the tax plan, but we expect the tax plan will make it through by early-January at the latest. The Alabama election reduces the margin for the Republicans starting in January, making every protest vote count. While there may be a risk-on bear steepening reaction when the bill passes, we look to use any such move to add to our flattener since most of the supply increase should occur in the sub-5yr sector.”

“Foreign demand for Treasuries remained very high in Q3 as evidenced by the Fed’s Flow of Funds data. While we don’t have much data for Q4, we think foreign flows have remained supportive of the market. The move in the swap spread curve implies that much of this demand has been in the long-end.”