Fearing a Fed error, investors track less obvious parts of the yield curve


NEW YORK, Feb 3 (Reuters) – Investors looking to gauge the impact of the U.S. Federal Reserve’s rate hike plans are keeping tabs on the less-watched segments of the U.S. Treasuries market that appear to have priced in the risk of a strong economic crisis slow down.

The shape of the U.S. Treasury yield curve reveals expectations for monetary policy and economic growth, and curve inversions – which occur when short-term debt yields more than government bonds at maturity longer – are considered predict recessionsespecially in the closely followed two-year and ten-year gap. Read more

Analysts point to reversals in less followed sections of the curve: The yield premium on 10-year US Treasury bonds over seven-year bonds turned negative in intraday trade last week for the first time since mid-December, and futures have been reversing .

“Any time you see a reversal, it raises concerns,” said Edward Moya, senior market analyst at Oanda.

Technical factors may be contributing to some of these reversals, but some investors still see them as reflecting broader concerns that the US central bank could harm the economy by raising interest rates too aggressively to counter the inflation.

“Markets are still a little nervous about an overshoot from the Fed,” said John Herrmann, director of forecasting and strategy for US interest rates at NatWest Markets Securities.

“When I talk to customers, 90% of customers are in the camp that they fear over the next two to three years the Fed will make a policy mistake,” he said, highlighting concerns that the Fed may have to resort to lowering rates after raising them, should the expected policy tightening hurt the economic outlook.

Yields on short-term US government bonds have risen at a much faster pace this year than longer-term bonds, flattening the curve on expectations of an aggressive path of interest rate hikes.

“This kind of dynamic in the spot market is going to translate into much flatter forward curves in the futures market,” said Subadra Rajappa, head of US interest rate strategy at Societe Generale.

“So it’s not something imminent…but it’s not something you totally ignore either.”

The yield curve steepened slightly this week after Fed officials spoke cautiously about the central bank’s trajectory after a widely expected hike in March.

“RARE EVENT”

Investors generally view reversals between two-year and 10-year notes as a classic sign that a recession could be coming in about one to two years. This part of the curve is not close to reversing, although it has flattened strongly.

Other reversals, such as the one between three-month bills and 10-year notes, are also being closely watched for their recessionary antecedents. This gap is also not close to reversal.

However, other parts of the curve have reversed.

The 7s/10s spread briefly turned negative last week. The 20/30 spread, in negative territory since the end of October, widened to around -6 basis points from -3.30bp on 31 December.

These parts of the curve are influenced by supply and demand dynamics, making them less relevant to recession risk. For example, pension and insurance companies looking to invest for the long term tend to put their money in 30-year bonds more than 20-year bonds, which narrows the spread between those two maturities.

Additionally, in a flight-to-safety scenario, such as when stocks fall, investors would typically buy 10-year Treasuries, reducing their premium over seven-year paper.

Still, “it’s really hard to know how technical this is versus something fundamental,” Rajappa said in reference to the brief reversal in the 7s/10s curve.

In the futures market, which prices Treasuries for future deliveries, the two-year forward curve measuring the spread between two-year and 30-year Treasuries inverted on Monday, analysts said. from Citi in a note, calling it a “rare occurrence.”

Yields on five- and seven-year Treasury bills reversed in two- and three-year futures on Monday, Herrmann said.

Credit Suisse said on Wednesday that an inversion of the yield curve this time around may not be the perfect predictor of a recession, given current economic conditions and the Fed’s focus on reducing interest rates. inflation. Read more

Matthew Nest, global head of active fixed income at State Street Global Advisors, said he was focusing on the 2s/10s and 5s/30s curves, rather than the futures market. The 5s/30s curve has also flattened this year.

“Curve inversions usually lead to recession in 12 to 18 months, so if the curve inverts in two years, it’s likely to be three years before recession becomes a real threat,” Nest said.

Reporting by Davide Barbuscia; Editing by Megan Davies and Andrea Ricci


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