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Bond Report: Treasury yield curve shrinks to narrowest levels in years as two-year rate has biggest daily gain since March 2020

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The two-year Treasury yield marked its biggest one-day gain in almost two years on Thursday, a day after the Federal Reserve pointed to the possibility of a series of interest rate hikes starting in March to combat rising inflationary pressures.

Meanwhile, yields on longer-term government debt dropped by the most in almost a week. That shrunk the gaps between yields of various maturities to the narrowest levels in years, a possible sign of continued worry about the economic outlook by investors.

What are yields doing?

The 2-year Treasury note yield TMUBMUSD02Y, 1.190% rose 10.1 basis points to 1.190%, up from 1.089% a day ago. That’s the largest one-day gain since March 10, 2020, as of 3 p.m. levels, according to Dow Jones Market Data. The yield hit another 52-week high and continues to climb to the highest level since February 2020.
The 10-year Treasury yield BX:TMUBMUSD10Y declined 3.8 basis points to 1.807% from 1.845% on Wednesday at 3 p.m. Eastern Time.
The 30-year Treasury bond rate TMUBMUSD30Y, 2.093% declined 7.6 basis points to 2.090% from 2.166% on Wednesday afternoon.
Those are the largest one-day declines for the 10- and 30-year rates since Jan. 21.

What’s driving the market?

Yields were mixed on Thursday as investors continued to digest the Fed’s policy update from the prior session. On Thursday, the Treasury curve flattened to levels not seen since 2019-2020, signaling there may be limits to how far officials can go without triggering fears of an impending recession.

Read: Federal Reserve’s rate-hike plans may be exacerbating the risk of a U.S. economic slowdown in 2022, based on bond-market signals

Wednesday’s policy update from the rate-setting Federal Open Market Committee pointed to the start of a steady increase to interest rates, which could begin as early as mid-March, as the central bank battles pricing pressures.

“This is going to be a year in which we move steadily away from the very highly accommodative monetary policy that we put in place to deal with the economic effects of the pandemic,” Powell said at a news conference following Wednesday’s Fed policy meeting.

Meanwhile, data released Thursday suggests that the impact of the omicron variant of COVID-19 on the labor market may be fading. New applications for U.S. unemployment benefits fell by 30,000 last week to 260,000, signaling that labor-market disruptions tied to omicron are easing. That’s below the seasonally adjusted 265,000 initial jobless claims forecast by economists polled by The Wall Street Journal.

A reading of fourth-quarter gross domestic product showed that the U.S. economy sped up toward the end of 2021 before a late omicron surge, expanding at an annual 6.9% pace. U.S. durables-goods orders dropped 0.9% in December, the biggest decline since the 2020 downturn. And a sale of $53 billion in 7-year notes BX:TMUBMUSD07Y was “fair,” said BMO Capital Markets strategist Ben Jeffery.

What analysts are saying

“Our base case remains that the Fed will raise rates by 25 basis points in March, with additional hikes in June and September,” said Brian Rose, senior economist for the Americas at UBS Global Wealth Management. “However, as Powell made clear, the Fed is highly data dependent. If there are signs that high inflation is becoming entrenched, then the Fed is likely to raise rates at a more rapid pace. In our view, beyond the inflation data itself, wage growth and inflation expectations will be critical.”

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