By Yoruk Bahceli and Sujata Rao
(Reuters) – Two-year US Treasury bond yields rose on Monday above the cost of 10-year lending – the so-called reversal of the curve that often heralds an economic recession – with expectations that interest rates interest rates rise faster and faster than expected.
Fears that the U.S. Federal Reserve may opt for an even larger rate hike than expected this week to contain inflation led to two-year yields reaching their highest levels since 2007.
But there is also a view that aggressive rate hikes could bring the economy down in recession.
The gap between two- and 10-year Treasury yields dropped to minus 2 basis points (bp), before rising again to about five bp, Tradeweb prices showed.
The curve had reversed two months ago for the first time since 2019 before normalizing.
An reversal of this part of the yield curve is seen by many analysts as a reliable signal that the recession could arrive in the next year or two.
The move follows Friday’s investments in the three-year / 10-year and five-year / 30-year parts of the Treasury curve, after data showed that US inflation continued to accelerate in May.
Two-year Treasury yields rose to a 15-year high of around 3.25% before falling to 3.19%, while 10-year yields reached the same level, the highest since of 2018.
Friday’s data showed the largest annual rise in inflation in the United States in nearly 40 and a half years, with hopes that the Federal Reserve could halt its campaign to raise interest rates in September. Many believe that the central bank may need to increase the rate of hardening.
Barclays analysts said they now expect a 75 bp move from the Fed on Wednesday instead of the 50 bp that have been incorporated.
Money markets are now setting a cumulative price of 175 bp up in September and also see a 20% chance of a 75 bp move this week, which if implemented would be the largest one-meeting rise since 1994.
UBS strategist Rohan Khanna said the European Central Bank’s false communications along with the impression of inflation “have completely shattered this idea that the Fed may not offer 75 bp or that other central banks will move to a gradual rhythm “.
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“The whole idea came out of the drain … it’s when a turbo flattening of the yield curves is achieved. the Fed’s inflation peak is not far behind either, “Khanna added.
Meanwhile, bets on the US terminal rate, where the rate of Fed funds may peak this cycle, are changing. On Monday, they set prices to approach 4% by mid-2023, almost one percentage point since the end of May.
Deutsche Bank said rates now reached a high of 4.125% by mid-2023.
Some Fed observers are skeptical that the Fed will move faster with rate hikes. Pictet Wealth Management senior economist Thomas Costerg, for example, noted, for example, that most of the drivers of inflation, such as food and fuel, remain outside the control of central banks.
“Over the summer, they will be aware of growth data and housing that is starting to look more uncomfortable,” Costerg said. “I doubt they’ll do 75 bps … 50 bps is a big step for them.”
Treasury bond sales have pushed other markets to the brink, sending German yields to a 10-year high since 2014 and lowering the S&P 500 futures by 2.5%.
(Report by Yoruk Bahceli and Sujata RaoEdit by Dhara Ranasinghe and Mark Potter)