Is This The Real Reason Why The Treasury Curve Has Been Collapsing For A Month?

A 'funny' thing happened a month ago. The Treasury yield curve suddenly started to collapse... despite gains in stocks and positive economi data surprises... the question is, why?

Here's one possible reason why..

Originally submitted by GovTrader,

TL/DR: Tax reform creates pension fund incentive to buy 30yr bonds NOW.

Currently, the top corp tax rate in the US is 35%. It looks most likely that rate will drop to 20% when tax reform passes. If you are a corp with an underfunded pension fund, you get a tax incentive to fund the pension THIS YEAR vs in the future when the corp tax rate drops to 20%.

Why? Because contributions to the pension plan are tax deductible. You get a bigger tax deduction in 2017 then you will get in 2018 and onwards (assuming tax reform happens in something close to its current form...which it looks like it will).

Multiple primary dealers have reported pension buying in the 30yr sector over the past month, and coincidentally, 30yr bonds have rallied while the front end has sold off for the past month.

Pension funds have a favorite bond to buy...STRIPS (30yr zero coupon bonds - higher yield than normal coupon bonds, better asset/liability match..more price sensitive to changes in yield...bigger bang for your buck in a bond rally..and is a flattener to the yield curve). Pension funds don't trade very much....they tend to buy and hold.

So these flows will SIGNIFICANTLY flatten the 30yr curve...and that is exactly what we have been seeing.

US Treasury yield changes (basis points) since Oct 24, 2017

Mystery Solved.


The Alarmist BandGap Tue, 11/21/2017 - 16:25 Permalink

No, pension contributions for 2017 can be made as late as 15 September 2018, with tax deduction still attaching to 2017. This can take us to Black (pick your day) in October 2018.

But yes, a real unwind could happen as pension consultants, looking to generate fees for reshaping the clients' portfolios, tell clients that the bonds have hit their peak, that it is now time for mean reversion, and here's our bill.

In reply to by BandGap

Osmium Tue, 11/21/2017 - 15:00 Permalink

I guess another question would be does the collapsing treasury curve even matter?  Ctl P and everything is just fine, trust us.

lester1 Tue, 11/21/2017 - 15:05 Permalink

No. It's because Trump's tax plan is going to blow a massive hole in the budget deficit. Who's going to soak up all these new US Treasuries notes to pay for the tax cut??? More debt to buy equals higher interest rates. The banks are front running the tax reform bill and gettingnready for blowing up of the national debt ! 

govttrader Tue, 11/21/2017 - 15:06 Permalink

If the Pension Funds are buying 30yr bonds, they are also buying stocks, to keep up the asset allocation ratio.  So, what happens to ES when the pension funds stop buying in Jan 2018?   BOOM.

adr Tue, 11/21/2017 - 15:06 Permalink

It is a pretty stupid thing to do if you are going to buy and hold these bonds for the maturity to fund pensions. The rate of return is near zero and a tiny bear market in bonds will leave you dead in the water. Unless stocks tank 70%, there is little point in buying bonds at the current level. 

MrSteve JohnGaltUk Tue, 11/21/2017 - 19:05 Permalink

Note also, these hot bonds are called zeroes. They only appreciate if rates go down, otherwise, you are locked into the discounted "rate" until they are "redeemed". If rates go up, these zeroes become "sub-zero total returners" only until they are held to maturity, ignoring all mark to market malarky and such which pension funds have never done, nor will they ever do.

In reply to by JohnGaltUk

24Richie Tue, 11/21/2017 - 15:16 Permalink

The short end is largely moved by the Fed.  The long end moves according to the perception of inflation. If inflation stays tame the curve will continue to flatten and could invert.