Treasury Curve Flattens as Inflation Risk Stokes Hike Bets
(Bloomberg) -- The Treasury yield curve flattened sharply Monday as surging energy prices stoked inflation fears and added fuel to growing expectations that the Federal Reserve will have to lift policy rates as soon as next year.
The gap between 5- and 30-year yields shrunk to as little as 84.5 basis points, raising concerns over it potentially signaling a growth slowdown, before rebounding to about 88 basis points. The low Monday put the spread at its least since April 2020, a time when pandemic fears brought the global economy to a near shutdown. Five-year yields are up 4 basis points to around 1.168%, while the 30-year bond yield was down around 1 basis point at 2.03% at 12:36 p.m. New York time.
In February this slice of the curve had reached an over 7-year high of 167 basis points, reverting lower slowly thereafter as traders brought forward the start of Fed hikes after the central bank policy moved their own projections to June. Money-market traders see a fifty-fifty chance that the Fed lifts rates as soon as June, and are pricing in two full quarter point increases in the funds rate by the end of next year.
“There’s a perception that with the Fed set to announce tapering in November and possibly raising rates at some point next year that the economy is getting a little bit exhausted on the growth side,” said Tom di Galoma, managing director of government trading and strategy at Seaport Global. “That’s one of the reasons the curve is flattening.”
Traders have also been ramping up bets that the Bank of England hoists its policy rate following a hawkish signal from Bank of England Governor Andrew Bailey on Sunday.
To be sure, other sections of the yield curve, such as the historically more well-followed spread between 2- and 10-year Treasury yields, remains at wider levels. This gap hovers at about 117 basis points -- just about 30% below its peak this year of 162 basis points reached in March.
“I think the Fed kind of needs to re-tell the story here – as the market is taking the inflation rate and extrapolating it into the future at a pretty rapid rate,” Kathy Jones, chief fixed-income strategist at Charles Schwab & Co., said on Bloomberg television Monday. The “second half of 2022 is likely to see slow growth both domestically and globally and some easing of inflation pressures. So I think the fed needs to re-set the narrative.”
Consumer price index rose at a 5.4% annual pace last month, matching the largest gain since 2008.
Jones said that she sees it likely the Fed boosts rates once next year, but thinks the market pricing in 50 basis points of policy-rate tightening in 2022 is “a bit aggressive.”
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