Volume low, yield curve ends year flattest since 2007

NEW YORK: US Treasuries edged higher in a quiet session on Monday, ending a year in which the yield curve reached its flattest since 2007.

With markets shutting early on New Year's Eve and many investors out of the office, trading volume was well below average and yields stayed within a narrow range across maturities.

Any trades were related to positioning for the end-of-month close, said Lou Brien, market strategist at DRW Trading in Chicago.

Yields have been falling for two months on a flight to lower-risk investments as stock prices slid in volatile trading. But yields remained up for the year, particularly in shorter-dated maturities, as the US Federal Reserve raised interest rates four times in the last 12 months.

The rate hikes led to a flatter yield curve as returns at the short end rose faster than those of longer-dated maturities. The spread between two- and 10-year note yields, the most common measure of the yield curve, was its flattest since 2007, ending the year out around 18.8 basis points.

This winter's stock market gyrations have lowered investors' expectations of rate hikes in 2019. The probability of a 25 basis point rate hike in either May, June or July of 2019 has fallen from around 40 percent to around 15 percent today, according to CME Group's FedWatch tool.

Many investors expect the yield curve to keep flattening, with a decline in the 10-year yield - which reflects the market's view of the US economy's health - as Wall Street's decade-long bull run loses steam.

In studies by Piper Jaffray & Co, analysts noted that once the spread between two- and 10-year yields reaches between 10 and 15 basis points, there is a 50 percent chance of a recession.

"What that says to us is that if the Fed keeps moving, we should see the curve continue to flatten, kind of locking in a recession," said Justin Hoogendoorn, head of fixed income strategy at Piper Jaffray & Co. "If the Fed does slow or pause we could start to see a little more steepness in the market and then we wouldn't necessarily be locking in a recession."