When the European Central Bank signalled that its next likely rate move would be upwards, it triggered a sharp shift in interest rate expectations. The euro swaps yield curve dramatically inverted between the two-year and 10-year maturities shortly thereafter – the first time for benchmark European yields since the early 1990s.
"A lot of this interest rate move is a fundamental reversal, an unwinding of the market’s mispricing of where policy rates would go," says Mark Schofield, head of interest rate strategy at Citi.
Schofield argues that this shift started in March after the bailout of Bear Stearns and points to the fact that the US Fed funds futures strip has swung 200 basis points higher – a dramatic move for the front end of the curve.
With inflation clearly on all monetary policy makers’ agenda, sterling and US swaps yield curves have also inverted/flattened between the two-year and 10-year maturities.
| 2-10 yield curves invert/flatten |
| Historically, Inversion in 2s10s curve has lasted a long period of time |
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| Source: Credit Suisse |
It is a well-understood canon of financial markets that banks dislike inverted yield curves.