Bond Report: This part of the Treasury curve is in jeopardy of inverting, after Powell’s re-confirmation hearing

Most Treasury yields fell on Tuesday, with 10- and 30-year maturities posting their biggest declines in weeks, after Federal Reserve Chairman Jerome Powell assured lawmakers that the central bank would do what’s needed to combat persistently high inflation.

The spread between 2- and 10-year yields, along with the gap between 5- and 30-year rates, flattened on signs of lingering economic worries and one part of the yield-curve was threatening to invert.

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What are yields doing?

The 10-year Treasury note TMUBMUSD10Y, 1.741% yield fell 3.4 basis points to 1.745%, down from 1.779% at 3 p.m. Eastern Time. That’s the largest one-day drop since Dec. 16. Tuesday’s move snapped a six-trading-day streak of gains, according to Dow Jones Market Data. Yields move in the opposite direction to prices.
The 2-year Treasury noteBX TMUBMUSD02Y, 0.886% rate declined less than one basis point to 0.897% from 0.904% on Monday. The yield is down two of the past three trading days. Monday’s level was the highest since Feb. 27, 2020.
The 30-year Treasury bond TMUBMUSD30Y, 2.072% yield dropped 3.7 basis points to 2.072%, down from 2.109% a day ago. That was the largest one-day drop since Dec. 22.

What’s driving the market?

In his re-confirmation hearing before Congress, Powell said high inflation will last “well into the middle of this year,” and that the omicron variant of the coronavirus that causes COVID-19 may result in a “short-lived” pause in growth. He also told a Senate panel that moving away from the Fed’s current policy stance “should not have negative effects on the labor market,” as lawmakers pressed him on the central bank’s ability to tackle inflation.

Read: Powell paints the picture of a soft landing, says Fed can cool inflation without damaging labor market

Most bond yields moved lower after Powell’s testimony, with declines in the long end outpacing those in the shorter end and flattening the curve. In addition, the spread between 7- TMUBMUSD07Y, 1.684% and 10-year rates TMUBMUSD10Y, 1.741% teetered on the brink of inversion.

Traditionally, investors have worried about yield-curve inversions—a line plotting out yields across maturities that normally slopes upward—as it indicates when financial conditions are tight relative to the state of the economy.

Meanwhile, expectations for a series of rate increases in 2022 have been growing, according to the CME FedWatch Tool, which now reflects increasing odds of four or more hikes by year-end.

In a speech on Tuesday, Kansas City Fed President Esther George said the central bank should speedily reduce its enormous $8.5 trillion bondholdings to curb the highest U.S. inflation in almost 40 years and to discourage undue risk-taking.

Wednesday’s economic data will include the consumer-price index, which is expected to show a 7.1% headline year-over-year rise for December, which would represent the highest level in four decades and has the potential to further solidify the market’s rate-hike expectations. 

On Thursday, Fed Gov. Lael Brainard will testify in front of the same Senate panel as Powell’s, as she aims to succeed Vice Chairman Richard Clarida, who will step down on Friday, two weeks earlier than expected after becoming embroiled in a controversy involving a stock transaction in 2020.

Meanwhile, an auction of $52 billion in 3-year notes BX:TMUBMUSD03Y came in “strong,” according to Michael Reinking, a senior market strategist for the Intercontinental Exchange ICE, +0.34% -owned New York Stock Exchange.

What analysts are saying

“All things considered, we agree that the first interest rate hike will probably now come at the March FOMC meeting, whereas we previously expected a June liftoff,” said Paul Ashworth, chief North America economist for Capital Economics. “An earlier first rate hike has also persuaded us that there will be four 25bp rate hikes this year rather than three.”
With fixings traders expecting a headline, year-over-year CPI figure of 7% for December, plus two more readings above that level for January and February, “if we actually see those types of numbers, anyone who is not looking for at least four rate hikes would be adjusting their forecast, and would probably be pushed to look at another four rate hikes in 2023,” said Tom di Galoma, managing director of Treasurys trading at Seaport Global Holdings. “The two-year yield is the most vulnerable part of the bond market, and should be at 1.5% by March of this year, or 2% and 2.5% in early 2023.”

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