Forex Investment and Currency Trading

The normal market pattern is bullish steepening as the Fed eases, and bearish flattening as the Fed tightens. However, one thinks that 2yrs are near the level where the pattern gets inverted—as 2s approach the 0% floor on yields, they cannot keep pace in a market rally. So the curve tends to flatten in a rally, and steepen in a selloff. This change was clear when the Bank of Japan took rates down to 0%. Initially, the easing caused steepening, and then once 2yr swaps moved inside of 1%, easing caused flattening. The US curve may exhibit this behavior in 2009.

Overall, look for the curve to steepen as there is likely to be less foreign support for the long end due to the weaker dollar, the reduced petrodollar bid with oil prices down dramatically, and the diminished buying from emerging markets whose governments need the surplus cash for domestic purposes.