Yields rise to decade highs, curve inverts on growth fears

By Karen Brettell

(Reuters) – Benchmark 10-year Treasury yields hit their highest level since 2011 on Monday and a key part of the yield curve inverted for the first time since April as investors braced for the prospect that the Federal Reserve’s attempts to stem soaring inflation will dent the economy.

Yields jumped after data on Friday showed that U.S. consumer prices accelerated in May as gasoline prices hit a record high and the cost of food soared, leading to the largest annual increase in nearly 40-1/2 years.

The Fed is expected to hike rates by 50 basis points when it concludes its two-day meeting on Wednesday, with traders now seeing a 75 basis point increase as having a 27% probability.

UBS strategist Rohan Khanna said hawkish European Central Bank communication alongside the inflation print “have completely shattered this idea that the Fed may not deliver 75 bps or that other central banks will move in a gradual pace”.

Investors are pricing in the likelihood that the Fed will hike rates higher than previously expected this cycle as it tackles stubbornly high prices pressures.

Fed funds futures traders now expect the Fed’s benchmark rate to rise to 3.88% by May, almost one percentage point higher than was expected last month, and up from 0.83% now.

Deutsche Bank said it now sees rates peaking at 4.125% in mid-2023.

As the Fed tightens policy, nerves about an economic downturn are rising. The two-year, 10-year Treasury yield curve briefly inverted on Monday, a reliable indicator that a recession will following in one-to-two years.

Jim Vogel, an interest rate strategist at FHN Financial, however, said a recession is not currently priced into the market.

“There is a fear that the Fed or any central bank can tighten us into a global slump, but not an outright recession, elsewise the peak of the Treasury curve wouldn’t be the five-year, it would be the two-year,” Vogel said.

Two-year yields reached 3.250%, the highest since Dec. 2007. Five-year yields rose to 3.434%, the highest since July 2008, Benchmark 10-year yields hit 3.295%, the highest since April 2011.

The yield curve between two-year and 10-year notes inverted as far as two basis points, before rebounding to positive territory at seven basis points. The gap between two-year and five-year note yields remained positive at 19 basis points.

The curve between five-year and 30-year yields inverted by as much as 17 basis points, after reinverting on Friday for the first time since May 4.

Some Fedwatchers, meanwhile, are sceptical the U.S. central bank will move faster with rate hikes. Pictet Wealth Management’s senior economist Thomas Costerg noted, for instance, that most inflation drivers such as food and fuel remain outside central bankers’ control.

“Over the summer, they will be aware of growth data and housing which is starting to look more wobbly,” Costerg said.

June 13 Monday 9:57AM New York / 1357 GMT

Price Current Net

Yield % Change

(bps)

Three-month bills 1.405 1.4293 0.066

Six-month bills 2.0775 2.1281 0.168

Two-year note 98-168/256 3.2119 0.163

Three-year note 98-136/256 3.3941 0.169

Five-year note 96-130/256 3.3956 0.143

Seven-year note 96-48/256 3.3688 0.129

10-year note 96-156/256 3.278 0.121

20-year bond 95-136/256 3.5651 0.115

30-year bond 91-224/256 3.3046 0.107

DOLLAR SWAP SPREADS

Last (bps) Net

Change

(bps)

U.S. 2-year dollar swap 39.75 2.75

spread

U.S. 3-year dollar swap 19.75 1.25

spread

U.S. 5-year dollar swap 5.00 1.00

spread

U.S. 10-year dollar swap 6.75 0.75

spread

U.S. 30-year dollar swap -24.25 0.25

spread

(Additional reporting by Yoruk Bahceli and Sujata Rao in London; Editing by Dhara Ranasinghe, Mark Potter and Angus MacSwan)