Yield curve flattens as Fed rate hike comes into focus amid steadying inflation fears
Long-dated Treasury yields fell on Wednesday, while short-dated yields rose, as moderating inflation fears shifted investor attention back onto an already expected rate hike by the Federal Reserve next week and away from expectations that the central bank could hike more aggressively this year.
How are Treasurys performing?
The 10-year Treasury note yield TMUBMUSD10Y, -1.09% rose 1.6 basis point to 2.278%, according to Tradeweb data, while the 30-year bond rate TMUBMUSD30Y, -1.47% known as the long bond, shed 2.2 basis points to 3.079%.
But shorter-dated rates rose, with the two-year note yield TMUBMUSD02Y, +0.00% falling 0.9 basis point to 2.839%.
Bond prices and yields move in the opposite direction.
What’s driving trading in government bonds?
Inflation expectations have moderated after a string of milder-than-expected economic data has plumped up longer-dated bonds, pushing their yields lower. At the same time, investors are expecting a rate hike on March 21, lifting the shorter-dated yields that are more sensitive to Fed action. The fed fund futures market, where traders can make bets on the course of coming interest rates, reflected an 88.8% chance of a 0.25 percentage point rate hike.
The combination of the two forces have helped flatten the yield curve, a line tracing a bond maturities against yields. A flatter yield curve tends to come during periods of monetary tightening but can also reflect the impending end of the U.S.’s economic boom as an inverted curve is almost always a prelude to a recession.
Government bonds have mostly drifted higher this week but have been held in check around 2.90%, but the climb in yields has drawn questions about whether a bear market in Treasurys, which have prospered amid easy-money policies, could be coming to an end.
Meanwhile, late Tuesday, Reuters reported that the White House was looking at imposing up to $60 billion in tariffs in Chinese goods, according to Reuters. The move would come after President Donald Trump imposed duties on aluminum and steel imports last week.
China’s holdings of U.S. Treasurys have come into focus amid the tariff developments. Data for November, showed that U.S. government paper held by Beijing has been decreasing, which could add further pressure to bond prices, driving yields up, market participants have said (paywall).
Investors also are closely watching personnel changes in the White House, with the announcement on Tuesday that Secretary of State Rex Tillerson would be replaced by Central Intelligence Agency Director Mike Pompeo. coming just a week after Gary Cohn, the president’s chief economic adviser, announced his resignation. The moves have elevated concerns of turmoil in the White House that make implementing market-friendly policies a challenge.
What are strategists and traders saying?
“How bad could a bond bear market be for fixed income investors? We pulled 9 decades of 10-year Treasury returns and CPI inflation data to answer that question,” wrote Nick Colas and Jessica Rabe, market analysts at DataTrek Research, wrote in a Wednesday research note.
“The bottom line: as long as markets feel the Federal Reserve is competently addressing inflationary pressures, bond bear markets only last 12-24 months. The risk, however, is that yields are so low that even a modest bear market will create outright losses, rather than just seeing Treasurys lag inflation,” the analysts wrote.
Which data are in focus?
Retail sales fell 0.1% in February compared to a 0.3% forecast from economists polled by MarketWatch. That marks the third decline a row, a record last matched in 2012.
The producer-price index rose 0.2% in February, slightly above economists’s expectations of 0.1%. Analysts expected the wholesale price reading to moderate from a hot 0.4% in January.
Which other assets are worth watching?
The German 10-year government bond yield TMBMKDE-10Y, -4.54% was at 0.609% on Wednesday, compared with 0.617% late Tuesday. German bonds, also known as bunds, are often viewed as a proxy for the health of the eurozone.