The US yield curve is steepening after Fed Chair Powell signaled a more cautious approach. The gap between the US 10-year and 2-year yields is the widest it’s been since May. Also, the difference between the 30-year and 2-year yields is the largest since 2022. This indicates that the market expects short-term rate cuts, but long-term yields are higher due to inflation and growth worries.

The Fed’s Temporary Stance

The Fed appears to be taking a temporary approach, similar to what it did after the Covid recovery. However, the bond market seems doubtful. The steeper curve might indicate possible mistakes by the Fed, particularly with stagflation risks that go beyond just slowing inflation. With talks of a rate cut in September, short-term yields are likely to drop, while long-term yields may remain stable due to persistent inflation expectations. Although it is not the same, this situation is reminiscent of the 1970s, hinting at increasing financial stress from ongoing inflation. In this context, gold could greatly benefit. Its historical role as a safeguard against inflation and currency fluctuations makes it a strong choice. Investors may find gold increasingly attractive as a protective asset. Given the widening gap between short and long-term yields, we should look at trades that can profit from a continued steepening of the yield curve. A classic steepener trade would involve buying 2-year Treasury note futures while selling 10-year or 30-year bond futures. The spread between the 10-year and 2-year Treasury yields has already expanded to over 55 basis points this week, a level not seen since the market chaos of early 2023.

Opportunities in Short Term Interest Rate Futures

The market is now forecasting an 85% chance of a rate cut in September, creating an opportunity in short-term interest rate futures. Going long on SOFR futures that expire after the meeting could capitalize on the expected decline in short-term yields. This strategy anticipates the Fed’s policy changes will directly affect the front end of the curve. The market’s doubts about the Fed’s plan are understandable, especially after the latest core CPI showed a 3.1% increase year-over-year. This ongoing inflation is likely keeping long-term yields high while short-term yields fall, which contributes to the steepening curve. Essentially, we are betting that the Fed might be making a policy mistake, similar to the initial inflationary phase after 2021. This environment strongly supports a positive outlook on gold as a hedge against potential stagflation. Gold has recently tested $2,450 per ounce, and there is a noticeable increase in call option volume on December gold futures (GC). Buying call options on gold or gold-related ETFs provides a defined-risk opportunity to profit from this uncertainty and the Fed’s challenging situation. Create your live VT Markets account and start trading now.

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