Passive funds drive record trading surges while global deficits reshape yield curve opportunities
Ultra-long sovereign bond yields may not stay subdued for long, as persistent budget concerns in the United States, euro zone, and Japan continue to drive volatility and opportunity in global fixed income markets, according to Reuters.
This dynamic has kept the curve steepening trade—where investors bet on the widening gap between short- and long-term yields—at the forefront of market strategies this year.
Investors have responded swiftly to governments that increase spending or fail to rein in deficits by selling long-term bonds, pushing borrowing costs for some countries to multi-decade highs, while showing more leniency toward shorter-dated bonds.
As reported by Reuters, ultra-long Japanese bond yields recently hit record highs and French yields neared 16-year peaks, with shorter-dated yields rising more modestly amid political turbulence.
Curve steepening has been the dominant trade, with the gap between 10- and 30-year bond yields growing by 36 basis points in Germany, 37 in US Treasuries, and around 40 in Japan, according to Reuters.
Although these spreads peaked in early September and have since retreated, many portfolio managers remain positioned for further steepening.
“We have been tactically taking profit (on the 10s30s steepener in the US and euro area), but we still have it,” said Reine Bitar, senior portfolio manager at Amundi, citing the ongoing pressure on government budgets.
National debt agencies in major economies have responded by shifting issuance toward shorter maturities and reducing long-dated supply, seeking to prevent further volatility in the long end, as noted by Reuters.
Meanwhile, structural changes such as Dutch pension reform and evolving central bank policies are also influencing the shape of the yield curve, with Morgan Stanley highlighting these factors as key catalysts.
In the US, the debate extends beyond deficits to include inflation risks and concerns over Federal Reserve independence.
Any perception that the Fed might bow to political pressure to cut rates more quickly could further steepen the curve by driving inflation expectations higher, as per Reuters.
For Canadian advisors monitoring global trends, trading activity in US Treasuries is also noteworthy.
According to new research by the Federal Reserve Bank of New York, trading volume in the US$30tn US government bond market surges by about 58 percent above average on the last trading day of each month, driven by index rebalancing and the growing influence of passive investment funds.
Bloomberg reports that ETFs and mutual funds now account for about 38 percent of bond fund assets, up from 32 percent five years ago, with the largest Treasury ETFs holding nearly 11 percent of all outstanding US notes and bonds.
As daily trading in Treasuries reached a record in 2024, the growth has been attributed primarily to increased activity from asset managers, reported by Bloomberg.
