A 'funny' thing happened a month ago. The Treasury yield curve suddenly started to collapse… despite gains in stocks and positive economi data surprises… the question is, why?
Here's one possible reason why..
TL/DR: Tax reform creates pension fund incentive to buy 30yr bonds NOW.
Currently, the top corp tax rate in the US is 35%. It looks most likely that rate will drop to 20% when tax reform passes. If you are a corp with an underfunded pension fund, you get a tax incentive to fund the pension THIS YEAR vs in the future when the corp tax rate drops to 20%.
Why? Because contributions to the pension plan are tax deductible. You get a bigger tax deduction in 2017 then you will get in 2018 and onwards (assuming tax reform happens in something close to its current form…which it looks like it will).
Multiple primary dealers have reported pension buying in the 30yr sector over the past month, and coincidentally, 30yr bonds have rallied while the front end has sold off for the past month.
Pension funds have a favorite bond to buy…STRIPS (30yr zero coupon bonds – higher yield than normal coupon bonds, better asset/liability match..more price sensitive to changes in yield…bigger bang for your buck in a bond rally..and is a flattener to the yield curve). Pension funds don't trade very much….they tend to buy and hold.
So these flows will SIGNIFICANTLY flatten the 30yr curve…and that is exactly what we have been seeing.
US Treasury yield changes (basis points) since Oct 24, 2017