In the wake of the recent US election, financial markets have witnessed a series of sharp moves across rate pricing. However, UBS’s Global Rates Strategy team believes that most of these sudden adjustments should be approached with caution—or even faded—meaning that investors might consider stepping back from the current direction of these rate moves.

Election Volatility: What It Means for Rates

The election stirred volatility across the financial spectrum, impacting everything from equities to bond yields. One outcome of the election has been a considerable re-pricing across various segments of the interest rate market. Yet, UBS analysts argue that most of these rate adjustments might be overstated, with breakeven (BE) rates as the main exception.

Breakevens, which reflect the market’s expectations of future inflation, have responded significantly to the election outcomes. Given the market’s current inflation outlook, this shift may make sense in the short term. However, when looking at other areas of the yield curve, UBS strategists see less justification for the recent movements.

Inflation vs. Supply: What Really Impacts the Curve?

The UBS team points out that the inflationary effects of tariffs, which tend to “flatten” the yield curve, are likely to have a stronger near-term impact than potential shifts in supply, which typically act as a “steepener.”

Let’s break that down:

• Tariff-driven inflation: Inflationary pressures caused by tariffs lead to a flattening effect on the yield curve, especially on longer-dated bonds. This is because inflation typically encourages central banks to raise short-term interest rates, reducing the spread between short- and long-term rates.
• Supply-driven steepeners: On the other hand, increases in bond supply could put upward pressure on long-term yields, which would steepen the yield curve. However, UBS strategists see any supply-driven steepening as less impactful in the near term than the deflationary or inflationary pressures stemming from tariffs.

Recent Steepener Trends: Little to Write Home About

Looking back to September, steepener trades—where investors bet on a widening spread between short-term and long-term yields—have yielded minimal returns. For instance, the 2s10s spread (the difference between two-year and ten-year Treasury yields) has remained tightly range-bound despite the election and other macro factors. Meanwhile, the 5s30s spread (five-year versus thirty-year Treasury yields) is currently 17 basis points flatter than it was in late September.

This flattening trend suggests that while investors might expect more divergence between short- and long-term rates, the market doesn’t seem to be rewarding such a strategy at the moment.

Key Takeaways: What This Means for Investors

Given these factors, UBS’s advice to investors is clear: approach recent rate moves with caution, particularly when considering steepeners. Here’s why:

1. The inflation impact of tariffs is likely to play a larger role than modest shifts in supply, leading to a flattening effect that dampens the appeal of steepener trades.
2. Breakevens are the exception, as inflation expectations remain elevated. For investors focused on inflation protection, breakeven rates might offer more attractive opportunities.
3. Steepeners are underwhelming: With little performance to show for steepener trades since September, the case for expecting larger spreads between short- and long-term rates looks weaker.

As we navigate post-election market dynamics, UBS’s message is one of tempered expectations. While the election brought significant changes, many of these moves may be short-lived. With that in mind, fading the current sharp moves—especially steepeners—may offer a more prudent strategy, while keeping an eye on breakeven rates for inflation-related opportunities.

As always, keeping a close watch on the yield curve and understanding the forces at play, from tariffs to supply changes, will be essential for those looking to make the most of the evolving interest rate landscape.