Expectations of more aggressive Fed crush U.S. yield curve

By Karen Pierog and Gertrude Chavez-Dreyfuss

Oct 28 (Reuters) - Investors are gauging what a furious flattening of the U.S. yield curve suggests about expectations for growth and how aggressively the Federal Reserve may tighten monetary policy in the face of surging inflation.

Yields on 20-year Treasuries rose above those on 30-year bonds several times on Thursday, a move analysts pinned on technical factors, including higher demand for much more liquid 30-year bonds. Yields move inversely to bond prices.

Market participants watch the shape of the yield curve to extrapolate investor expectations for U.S. growth and monetary policy. Inverted curves have at times presaged https://www.reuters.com/article/us-usa-economy-yieldcurve-explainer/countdown-to-recession-what-an-inverted-yield-curve-means-idUSKBN1ZR2EX recessions and some analysts said the slope starting at the short end of the yield curve matters most for the economic outlook.

"I would not take the 20/30-year yield inversion as a recession signal," said Dan Belton, a fixed income strategist at BMO Capital Markets in Chicago. "The move has a strong technical component given that it is entirely far out the yield curve. Further, no other benchmark rates have inverted."

"The market has priced a steeper rate hike path which has caused the entire yield curve to flatten, although not invert," Belton said.

Fed policymakers are expected to announce plans to taper the central bank's $120 billion in monthly purchases of Treasuries and mortgage-backed securities at the conclusion of their meeting on Nov. 3.

Expectations that rising inflation will bring a quicker start to Fed interest rate hikes have pushed short-term yields higher in recent days, while long-term ones have fallen as the market bets that rates will not end up as elevated as previously forecast, analysts said. "The market is saying that the Fed will raise rates sooner than previously thought, and in so doing will kill any semblance of inflation and so will have less need to raise rates later," said Roberto Perli, head of global policy at Cornerstone Macro.

As a result of the yield moves, the closely watched gap between two- and 10-year notes narrowed to as much as 97.7 basis points earlier on Thursday, making the curve the flattest it has been since August, though it is not nearing inversion. At 73.4 basis points, the five-year note to 30-year bond yield curve was at its flattest since March 2020.

However, recent flattening in the three-month bill to 10-year note curve has been not as extensive with the spread, which started this week at 158.6 basis points, currently around 151 basis points.

Another factor in the curve flattening is uncertainty over another term for Jerome Powell as Fed chair and a possibility of a more hawkish central bank, according to a Cornerstone Macro report on Thursday.

"We should see a partial reversal of the recent curve flattening should Powell be reconfirmed," it said. "We say partial because doubts about persistent inflation will remain, and it will take lower actual inflation to substantially reduce expectations of rate hikes." (Reporting By Karen Pierog and Gertrude Chavez-Dreyfuss; Editing by Ira Iosebashvili and Chizu Nomiyama)