Beware the Carry Hole that Is the 2s10s Steepener

The yield curve has steepened. 2s are dropping versus 10s but cash rates are still high.

Odds are, the curve keeps steepening — whether from Fed normalization, a crisis taking the bottom out of the front-end, or tariff-driven inflation blowing the back out of the 10-year. 

Should we care?

Not unless you can take leverage and pain in equal measure, have flawless timing, or run a well-oiled systematic approach. Even the curve’s “signals” aren’t as reliable as they once were.

The market’s invisible hand is being bent by monetary, fiscal and political expediency:

• The Fed is under pressure.

  
  

• The Treasury is front-loading issuance into short maturities.

  
  

• Tariff wars make the inflation outlook a guessing game.

One thing is certain: if you put on the steepener by selling 10s and buying 2s, you’ll pay for the privilege. I’ve warned twice in the last year that negative carry makes the path to profit an uphill battle. The curve is now >50bps steeper since the first post — if you put the trade on, you’d be directionally right and very slightly poorer.

Here’s why:

• Structure: To be risk neutral, you need ~4x your 10-year short in 2-year longs. For ~20% notional in 2-year futures you need 5% in 10-year futures. That’s a lot of notional exposure to tie up.

  
  

• Payoff: For each basis point of 2s10s steepening, you make ~0.4bps. A 100bp steepening? ~0.4% return. You need leverage to actually make money.

  
  

• Carry: Every day you bleed — the 2-year rolls up to cash, the 10-year rolls down toward the 2-year. You need the move to be fast, or massive. 

Even during the GFC, when the Fed cut 500bps and 2s10s steepened by 200+bps the carry adjusted return would have been less than a point on a 25% notional position.

If you believe the curve will steepen — whether from cuts, stagflation, mean reversion, or normalization — there are better ways to express that view:

• Aggressive cuts? Own the 5-year outright.

  
  

• Stagflation? Short the 10-year.

  
  

• Normalization? Own risk assets.

The 2s10s steepener might be a good story, but it’s never been much of a trade.