JP Morgan expects ‘steeper’ yields curve in 2H, points to Fed ‘policy mistake’

Strategists at JP Morgan told investors to “fade” the bounce in Defensive issues seen over the past two to four months, telling them that it was too soon to begin positioning for ‘late cycle dynamics’.
The government bond curve had flattened since the US central bank’s meeting in June, but financial markets were warming up the idea that the Fed had made a ‘policy mistake’.

Hence, their expectation was that the flatter curve would end up turning out to mark the end of the capitulation phase of the ‘consolidation trade’ in force seen since April.

“We look for higher bond yields in 2H, a steeper yield curve, and a return to beta leadership,” they argued.

“The Fed is likely to keep reassuring the market that it will stay highly sensitive to growth developments, not careering too far to a hawkish mode.”

Indeed, while economic growth momentum had peaked, growth in activity was likely to remain “significantly” above trend – “Delta variant willing”.

To further back up their case, they pointed to the fact that the bulk of the economy’s reopening remained ahead of them, financing conditions remained “very easy”, and credit spreads and real rates were too low to be thinking yet about end-cycle dynamics, they said.

“Historically, on most occasions, barring the “policy mistake” periods, short rates tended to drive long rates higher, and this could be the case yet again, once the dust settles. The bounce in a number of Defensives in the past 2-4 months, such as in Staples, Real Estate and Healthcare, should be faded.”

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