Bond market fireworks highlight recession worries

A security guard walks past an image of the Federal Reserve following the Federal Open Market Committee’s (FOMC) two-day policy meeting in Washington, March 16, 2016. REUTERS/Kevin Lamarque

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NEW YORK, March 21 (Reuters) – Sharp moves in the U.S. Treasury market increasingly signal the risk of a looming recession, with “bond vigilantes coming out of the woods” and markets doubting the Reserve’s plan federal government aimed at creating a “soft landing” for the economy as it raises interest rates to fight inflation, market experts said.

Fed Chairman Jerome Powell said on Monday that the U.S. central bank needed to act “quickly” to rein in too-high inflation and could use larger-than-usual interest rate hikes if necessary. Bond yields, which move inversely to prices, rose as the US Treasury yield curve continued its flattening trend. Read more

“The market appears to be questioning the vision of a soft landing for the US economy that the Fed championed at the March FOMC meeting,” BofA strategists said.

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The U.S. Treasury yield curve reflects “recession risks, and not just through the extreme flattening of the curve at the start of the Fed’s tightening cycle,” the strategists said.

The tightly tracked part of the yield curve measured between 10-year and two-year Treasuries has narrowed by about 60 basis points since the start of the year, with longer-dated bonds now yielding less 20 basis points more than two-year Treasury bills. debt.

Any reversal of this part of the curve, where shorter ratings pay more than longer ratings, is generally considered to portend a recession of six to 24 months. Read more

“The yield curve looks worrying,” wrote Christopher Murphy, co-head of derivatives strategy at Susquehanna Financial Group, though he said an inversion doesn’t always guarantee a recession.

Melissa Brown, global head of applied research at Qontigo, said the yield curve reflects a shift in market sentiment on the Fed’s ability to tighten monetary policy just enough to reduce inflation without plunging the economy. in a recession.

“The market may be assuming they can’t thread that needle…it’s going to be hard not to drive us into recession,” she said.

Still, Powell said Monday he doesn’t see a high likelihood of a recession next year and others are skeptical of such an event.

That prompted fed funds rate futures on Monday to boost the odds of a half-percentage-point tightening at the next policy meeting in May. Read more

NatWest analysts said Powell was “clearly warning about 50 basis point upside risk(s) in upcoming meetings,” which they said sent Treasuries “into a tailspin.”

Asked about concerns about the yield curve on Monday, Powell said he was focusing on the short end of the curve, meaning the first 18 months of maturities.

Morgan Stanley said in a research note on Sunday that a yield curve inversion is possible in the second quarter of this year, but an inversion does not necessarily anticipate a recession.

“However, it confirms our view of a sharp deceleration in earnings growth,” he said.

For Tim Holland, chief investment adviser at Orion Advisor Solutions, a recession is not imminent, despite the flat curve.

Another part of the curve that compares three-month bills to 10-year bills has steepened this year, from 145 basis points on December 31 to 181.54 basis points on Monday.

“If the past 30 years is any guide, both sides of the curve need to flatten and reverse before we risk a recession,” he said.

Powell’s speech Monday at a National Association for Business Economics conference caught some market participants off guard as they sounded more hawkish than his remarks after the Fed hiked the federal funds rate by 25 points last Wednesday. basic.

Yields soared on Monday with the benchmark 10-year note to a yield of 2.298% from 2.153% on Friday – the highest since May 2019. Yields on two-year Treasuries, which more closely reflect the monetary policy expectations, jumped to 2.111% from May 2019. 1.942% on Friday.

“What you saw today was Powell throwing in the towel, he said he would do whatever it takes, and that kind of pushed the market back a bit,” said Andrew Brenner, Head of International Fixed Income at National Alliance Securities.

Brenner described the behavior of the bond market as that of bond vigilantes – when investors insist on high yields to offset the risk of inflation.

“The bond vigilantes are out of the woods,” Brenner said, adding that he’s seen a large amount of selling in the futures market, particularly focused on five-year futures.

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Reporting by Davide Barbuscia; additional reporting by Alden Bentley; Editing by Megan Davies, Hugh Lawson and Bernard Orr

Our standards: The Thomson Reuters Trust Principles.

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