Bond Report: Treasury yield curve flattens further as Fed’s favorite inflation gauge stays well above 2% and consumer sentiment remains low


The spread between 5-year and 30- year Treasury yields flattened further Friday to levels not seen since March 2020 with the Federal Reserve’s favored inflation gauge holding well above the central bank’s 2% target but U.S. consumer sentiment still near the lowest levels since the pandemic began. .

What are yields doing?

The yield on the 10-year Treasury note

was unchanged at 1.568%, compared with 1.568% at 3 p.m. Eastern on Thursday.

The 2-year Treasury note yield

rose to 0.501%, compared with 0.499% Thursday afternoon. Through Thursday, the 2-year yield had risen 21 basis points in October, on track for its largest monthly rise since April 2018, based on 3 p.m. levels, according to Dow Jones Market Data.

The 30-year Treasury bond yield

was down at 1.948% versus 1.962% on Thursday.

What’s driving the market?

The spread between the 5-year and 30- year Treasury yields narrowed further Friday morning, suggesting traders remain concerned about the economic outlook. The spread narrowed to 73.7 basis points as of 10 a.m. New York time on Friday, a level not seen since March 2020, according to Tradeweb.

Similar yield curves also flattened in the U.K., Germany, Italy, and France, as markets priced in more monetary policy tightening despite an uncertain global economic growth outlook. Meanwhile, rates on overnight-indexed swaps have risen in recent weeks for the U.S., U.K., and Australia, while those of Europe and Japan turned less negative, according to Tradeweb. OIS rates are another sign of markets pricing in further tightening by central banks.

U.S. data released Friday showed that the Federal Reserve’s favored inflation gauge held well above the central bank’s 2% target. The 12-month increase in the PCE index rose to 4.4% in September from 4.2% in the prior month. And the core PCE rate that strips out food and energy held steady at 3.6% on an annual basis.

Consumer sentiment remained near the lowest levels of the pandemic, based on University of Michigan data, and household expectations for inflation over the next year hit a 13-year high.

Personal income slumped 1% in September, versus the 0.4% decline that economists were looking for, as pandemic-related assistance programs wound down. However, consumer spending rose 0.6% in September as Americans dipped into their savings, a gain that was in line with forecasts of economists surveyed by The Wall Street Journal.

Analysts are looking for end-of-month position squaring on Friday, as investors also await next week’s Federal Reserve policy meeting, which is widely expected to see policy makers unveil plans to begin scaling back monthly bond purchases.

Rising yields at the short end of the curve are tied to expectations that central banks across the world will be more aggressive than previously expected to address inflationary pressures. Meanwhile, yields at the long end of the curve have either fallen or risen at a less aggressive pace than short-end rates have — a sign investors are worried about long-term economic growth prospects.

Read: Bond market yield curve flattening continues as U.S. growth slows, while ECB’s Lagarde pushes back on rate-hike expectations

Some analysts see a more benign explanation as U.S. stock indexes continue to march to records, arguing that the yield moves indicate investors don’t think it will take much for central banks to tame near-term inflation pressures. Even so, in a potentially troubling sign for the rest of the Treasury curve, the spread between 20- and 30-year Treasury yields has inverted — meaning the 20-year rate currently trades above the 30-year rate

See: Stocks rise to records as markets seem ‘pretty convinced’ it won’t take much to tame inflation

What are analysts saying?

“The transition toward a more hawkish global central banking stance has been the unifying theme across fixed income markets,” BMO Capital Markets strategists Ian Lyngen and Ben Jeffery wrote in a note. “While the FOMC is poised to announce tapering next week, the more relevant debate in the Treasury market is how quickly the Fed will deliver on the ambitious liftoff hikes already priced into the futures market. Our take remains that the better-than-even odds of the June liftoff are far overstated and the Fed will err in favor of a longer window between the end of bond buying and the first hike.”

Signs of monetary tightness are emerging around the world, with U.S. dollar liquidity “falling hard this morning,” according to Colin Stewart, head of Americas for Quant Insight. “Japanese and European banks and institutions are feeling incremental tightness in the ability to access USD funding.”

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