Yield curve uninverts on optimism over China trade deal

• The spread between three-month and 10-year Treasury yields widened by the most since May 6 and moved into positive territory.
• We've had chunky sell-offs here driven by hopes for better news in the discussions with China.

NEW YORK: The Federal Reserve's preferred measure of the yield curve on Friday uninverted for the first time since mid-July, as progress in US-China trade talks boosted the US economic outlook.

US President Donald Trump said on Friday the two countries had come to a substantial "phase one" trade deal on intellectual property, financial services and big agricultural purchases. Chinese Vice Premier Liu said they had made substantial progress in the talks, and will continue to make efforts.

The spread between three-month and 10-year Treasury yields widened by the most since May 6 and moved into positive territory. It had been inverted since late May save for two intraday pops in mid-July.

An inverted yield curve typically signals an upcoming recession. The Fed has identified the spread between three-month bills and 10 year-notes as a more accurate recession indicator than the gap between two- and 10-year yields.

The shift was mostly due to a rise in the 10-year yield on optimism about US-China trade talks, said analysts. The benchmark 10-year yield moves in step with the market outlook on economic health.

"We've had chunky sell-offs here driven by hopes for better news in the discussions with China," said Michael Cloherty, head of US rates strategy at RBC Capital Markets.

The trade war with China, now in its 15th month, has begun to depress US economic growth, raising chances that the Fed will cut interest rates cut in October. Those expectations fell on Friday.

"The Fed eased the last couple of meetings because of the implications of global developments, by which they meant the trade war and Brexit in particular," said Lou Brien, market strategist at DRW Trading, referring to the Federal Open Market Committee's policy-setting meetings.

"As you get optimistic on those things, you're getting a little pullback on Treasuries because maybe the economy will work a little bit better once those things are solved."

Also helping to widen the spread between 3-month and 10-year yields was a Fed announcement that it would start buying $60 billion per month in Treasury bills to ensure "ample reserves" in the banking system. Responding to recent disruptions in short-term money markets, the Fed emphasized the new program did not mark a change in monetary policy.

The two-year Treasury yield, a proxy for market expectations of moves in Fed interest rate policy, rose 9.8 basis points to 1.624%. The benchmark 10-year yield was up 10.3 basis points at 1.757%.