Long-term yields edge down, curve flattens on recession risk

NEW YORK: Long-term US Treasury yields edged down on Friday as lack of a resolution of the Russia-Ukraine conflict continued to weigh on markets, while short-term yields kept rising on the back of a hawkish US central bank, further flattening the curve.

Analysts and investors also pointed to some curve inversions as further signals of a likely economic slowdown ahead, with inflationary pressures related to the Ukraine crisis coming on top of monetary-tightening plans by the US central bank.

The benchmark 10-year yield was down to 2.145% from 2.167% and the 30-year yield was at 2.416% from 2.461% on Thursday, in a sign of risk aversion.

Meanwhile, yields on two-year Treasuries, which closely reflect monetary policy expectations, were up at 1.956% from 1.915%, a day after the Federal Reserve hiked interest rates for the first time since 2018.

“The yield curve flattened sharply on the back of the hawkish FOMC outcome, with a more aggressive than expected near-term path for hikes and faster transition to neutral or restrictive policy,” said Jonathan Cohn, head of Rates Trading Strategy at Credit Suisse. The FOMC is the Fed’s policy-setting committee.

The Fed on Wednesday raised its key lending rate by a quarter of a percentage point and forecast an aggressive path of further increases to counter inflation. Policymakers also trimmed economic growth projections for the year.

Fed Chair Jerome Powell’s “rhetoric made clear that the Fed intends to prioritize price stability with a higher tolerance for labor market weakness ... It’s definitely a framework that attempts to thread a difficult needle and one that justifies heightened recession expectations, which is likely contributing to curve flattening,” said Cohn.

The closely watched spread between yields on US two-year notes and 10-year ones was down to 18.7 basis points on Friday from 25.4 on Thursday, reflecting increasing concerns over the impact of tighter monetary policies on economic prospects.

An inversion of that part of the curve - where short-term yields move higher than longer ones - has generally indicated the risk of an upcoming recession.

Other parts of the curve showed some inversions, including the 7s/10s and the 20s/30s. The gap between 10-year notes and 5-year notes was flat at 0.1 basis points, but that curve also inverted intraday on Friday.

The yield gap between three-year Treasuries and the 10-year note, as well as between three- and five-year notes, also went into negative territory.

“All the signals are there for a meaningful slowdown in economic growth for the balance of this year and going into 2023,” said Steven Schweitzer, senior fixed income portfolio manager with the Swarthmore Group. “The balance is definitely shifting toward the higher probability of a recession.”