NEW YORK, March 21 (Reuters) - Sharp moves in the U.S.
Treasury market are increasingly pointing to the risk of an
approaching recession, with "bond vigilantes coming out of the
woodwork" and markets doubting the U.S. Federal Reserve's plan
to engineer a "soft landing" for the economy as it hikes
interest rates to fight inflation, market experts said.
Fed Chair Jerome Powell said on Monday the U.S. central bank
must move "expeditiously" to bring too-high inflation to heel
and that it could use bigger-than-usual interest rate hikes if
needed. Bond yields, which move inversely to prices, spiked
while the U.S. Treasury yield curve continued its flattening
"The market seems to be challenging the soft-landing view
for the U.S. economy that the Fed argued at the March FOMC
meeting," BofA strategists said.
The U.S. Treasury yield curve reflects "recession risks, and
not just through the curve's extreme flatness at the inception
of the Fed tightening cycle," the strategists said.
The closely followed 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 the longer-dated notes now yielding less than 20 basis
points more than two-year debt.
Any inversion of that part of the curve, when shorter notes
yield more than longer ones, is generally seen as presaging a
recession by six to 24 months.
"The yield curve does look ominous," wrote Christopher
Murphy, Co-Head of Derivatives Strategy at Susquehanna Financial
Group, although he said an inversion does not always guarantee a
Melissa Brown, Global Head of Applied Research at Qontigo,
said the yield curve is reflecting a shift in market views on
the ability of the Fed to tighten monetary policy just enough to
reduce inflation without throwing the economy into a recession.
"The market perhaps is assuming that they can't thread that
needle ... it's going to be tough to not drive us into
recession," she said.
Still, Powell on Monday said he did not see an elevated
likelihood of a recession in the next year and others are
skeptical of such an event.
That prompted Federal funds rate futures on Monday to raise
the chances of a half percentage-point tightening at the next
policy meeting in May.
Analysts at NatWest said Powell was clearly "warning of
risks to 50bp hike(s) at the coming meetings," which they said
sent Treasuries into "free fall."
When asked on Monday about concerns on what the yield curve
is saying, Powell said that he focused on the short end of the
curve, meaning the first 18 months of maturities.
Morgan Stanley said in a research note on Sunday that an
inversion of the yield curve was possible in the second quarter
this year, but that an inversion does not necessarily anticipate
"However, it does support our view for sharply decelerating
earnings growth," it 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 which compares three-month bills
with 10-year notes has steepened this year, from
145 basis points on Dec. 31 to 181.54 basis points on Monday.
"If the past 30 years is any guide, both parts of the curve
need to flatten and invert before we are at risk of recession,"
Powell's speech on Monday at a National Association for
Business Economics conference caught some market participants
off guard as they seemed more hawkish than his remarks after the
Fed last Wednesday raised the federal funds rate by 25 basis
Yields spiked on Monday with the 10-year benchmark note
up to a yield of 2.298% from 2.153% on Friday - the
highest since May 2019. Yields of two-year Treasuries
, which more closely reflect monetary policy
expectations, jumped to 2.111% from 1.942% on Friday.
"What you saw today is Powell basically throwing the towel,
he said he's going to do whatever it takes, and it took the
market a little bit back," said Andrew Brenner, head of
international fixed income at National Alliance Securities.
Brenner described the bond market behavior as that of bond
vigilantes - when investors insist on high yields to compensate
for the risk of inflation.
"Bond vigilantes have come out of the woodwork," Brenner
said, adding he saw a large amount of selling in the futures
market, particularly concentrated in five-year futures.
(Reporting by Davide Barbuscia; additional reporting by Alden
Bentley; Editing by Megan Davies, Hugh Lawson and Bernard Orr)