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Bond Report: Treasury curve remains inverted as yields rise after Fed’s hawkish minutes

Treasury yields rose to their highest levels in a week on Thursday as investors weighed the prospects for continued Federal Reserve rate hikes that could tip the U.S. economy into recession, keeping the curve inverted.

What’s happening

The yield on the 2-year Treasury
TMUBMUSD02Y,
3.028%

rose 7.8 basis points to 3.039% from 2.961% on Wednesday afternoon. The yield is up 230.9 basis points for the year.

The yield on the 10-year Treasury
TMUBMUSD10Y,
3.007%

advanced 9.6 basis points to 3.007% versus 2.911% as of Wednesday.

The yield on the 30-year Treasury
TMUBMUSD30Y,
3.199%

rose 7.8 basis points to 3.195% from 3.117% in the prior session.

Those are the highest levels for the 2-, 10- and 30-year rates since June 29, based on 3 p.m. levels, according to Dow Jones Market Data.

What’s driving markets

Investors digested the minutes from the Federal Reserve’s June meeting, published on Wednesday, and had little reason to change their view that Chairman Jerome Powell and colleagues may risk a meaningful economic slowdown in order to damp inflation.

In remarks on Thursday, Fed Gov. Christopher Waller said he backs big increases in the key U.S. interest rate target over coming months to drive U.S. inflation lower and to make sure the public doesn’t come to expect rapidly rising prices. Meanwhile, St. Louis Fed President James Bullard said he doesn’t see a U.S. recession on the horizon.

With U.S. inflation running at a headline annual pace of 8.6% for May, the Fed raised its main policy rate target by 75 basis points to between 1.50% to 1.75% last month. The June 14-15 minutes revealed that policy makers saw a significant risk that elevated inflation could become “entrenched,” and determined that a 50- to 75-basis-point rate hike at their next meeting would likely be appropriate. They also saw the possibility of an “even more restrictive stance” on monetary policy if price pressures persist.

The yield spread between the U.S. 10-year and 2-year bonds shrank to as low as minus 7.9 basis points on Thursday. A lasting inversion of the yield curve is taken as an early signal that growth prospects are souring as short-term interest rates rise.

That said, a markedly weaker labor market might give the Fed pause for thought, and investors will be eager to sift through U.S. nonfarm payrolls data, due on Friday. Economists are forecasting 250,000 jobs were added in June.

See: Hiring in U.S. likely fell to 18-month low in June —250,000 new jobs forecast

Data released on Thursday showed that 235,000 people applied for jobless benefits last week, marking the highest number in six months. And the U.S. international trade deficit narrowed 1.3% in May to $85.5 billion, the Commerce Department said Thursday.

In the U.K., British Prime Minister Boris Johnson resigned Thursday, acknowledging that it was “clearly the will” of his party that he should go. The wheels have been set in motion for a new U.K. leader, who faces an economy at risk of recession.

What analysts are saying

“Real interest rates in the belly of the curve have returned within 10bp of their highs just before June’s FOMC meeting, while long and short Treasurys easily surpassed those levels in yesterday’s selloff,” said Jim Vogel, executive vice president of FHN Financial. “As investors see real rates becoming more restrictive, the recession theme will gain more adherents even if current data align with a soft landing. That may (finally) bias the curve toward sustained flattening.”

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