Insights 
VT 
The US yield curve is steepening following a dovish stance from Fed Chair Powell. The spread between the US 10-year and 2-year yields is now the widest since May, and the gap between the 30-year and 2-year yields is the largest since 2022. This reflects market anticipation of short-term rate cuts while long-term yields account for a premium due to inflation and growth concerns.
The Fed’s Temporary Stance
The Fed is seemingly adopting a temporary stance reminiscent of its actions post-Covid rebound, yet the bond market appears sceptical. The steepened curve could suggest potential policy errors from the Fed, with prevailing conditions akin to stagflation risks over simply slowing inflation.
With discussions of a rate cut in September, short-term yields are anticipated to decrease, while long-term yields may hold steady amid ongoing inflation expectations. Although not identical, this situation recalls the 1970s, suggesting a rising financial burden due to lasting inflationary pressures.
In such a scenario, gold might greatly benefit, as its historical role as a hedge against inflation and currency volatility can reinforce the bullish case for the asset. The potential for gold to protect against economic fluctuations could become increasingly appealing.
Given the widening gap between short and long-term yields, we should consider trades that profit from a continued steepening of the yield curve. A classic steepener trade involves buying 2-year Treasury note futures while simultaneously selling 10-year or 30-year bond futures. The spread between the 10-year and 2-year Treasury yields has already widened to over 55 basis points this week, a level we haven’t seen since the market volatility of early 2023.
Opportunities in Short Term Interest Rate Futures
With the market now pricing in an 85% probability of a rate cut in September, we see an opportunity in short-term interest rate futures. Going long on contracts like SOFR futures that expire after the meeting could capture the expected drop in short-term yields. This move anticipates the Fed’s policy shift directly impacting the front end of the curve.
The market’s skepticism toward the Fed’s narrative is understandable, especially after the latest core CPI reading came in at 3.1% year-over-year. This persistent inflation is why long-term yields are not falling with short-term yields, creating the steepening effect. We are essentially betting that the Fed is making a policy error, reminiscent of the early stages of the inflationary period we saw after 2021.
This environment strongly supports a bullish view on gold as a hedge against potential stagflation. We have already seen gold test the $2,450 per ounce level, and there’s a noticeable uptick in call option volume on gold futures (GC) for December expiration. Buying call options on gold or gold-related ETFs offers a defined-risk way to profit from this uncertainty and the Fed’s challenging position.
