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CORRECTED-TREASURIES-Omicron and inflation flatten U.S. yield curve

·2-min read

(Corrects two-year Treasuries pandemic high in pargraph 3 to 0.687% from 0.6320%)

Dec 2 (Reuters) - Long-dated U.S. government bond yields neared their lowest for the year on Thursday as investors wagered that early rate hikes would curb future inflation, flattening the yield curve.

Thirty-year Treasury yields hit 1.74% in late New York trade on Wednesday, their lowest since January. They were as low as 1.75% on Thursday.

Meanwhile, two-year yields rose over 3 basis points (bps) on Thursday to 0.607%, not too far from their highest level since the pandemic of 0.687%.

Assuming that higher rates next year will ultimately translate to lower inflation and a lower peak in interest rates later on, traders have squeezed the closely-watched gap between two-year and 10-year yields to the narrowest in eleven months.

Worries about the Omicron variant have also lent a safety bid to bonds. Since news of the variant broke, just after Thanksgiving, benchmark 10-year yields have dived some 25 bps in a painful rally for a market heavily short.

"The bond market remains very, very jittery as liquidity is probably at rock-bottom levels," said Arne Petimezas, senior analyst at AFS Group in Amsterdam.

He noted that the yield curve flattening suggests markets are giving the Fed little room to tighten policy.

That "means less room for rate hikes before the yield curve flips," Petimezas said.

The first case of the Omicron variant was reported in the United States on Wednesday, adding to the unease.

Federal Reserve Chair Jerome Powell also this week flagged a chance of faster moves to head off inflation.

Ten-year yields stood at 1.4392% by 1144 GMT, up less than a basis point.

Real yields also rose, with the five-year inflation-linked bond yield rising 7 bps to its highest since June at -1.496%.

The 10-year real yield rose as high at -0.973%.

"Something has to give," said Deutsche Bank strategist Alan Ruskin. "Either long-term rates move higher, or, the terminal rate has to move higher, or both," he wrote in a research note.

"The alternative view is that the recovery is so mature or fragile the momentum fades without any policy push, or the massive helicopter liquidity drop fades and so does nominal GDP...but even then, surely more than 150 bps of tightening are needed to slow 11% nominal GDP growth down to a more sustainable 4%."

(Reporting by Tom Westbrook and Yoruk Bahceli; Editing by Devika Syamnath)

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