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Bond Report: Treasury yield curve flattens after Fed’s Powell underlines inflation risks

Long-dated U.S. Treasury prices rallied Friday, pushing down yields and contributing to a further flattening of the yield curve, after Federal Reserve Chairman Jerome Powell signaled the central bank is prepared to begin tapering its monthly asset purchases and warned that inflation is likely to remain elevated into 2022.

What are yields doing?

The 10-year Treasury note

yielded 1.654% at 3 p.m. Eastern, down from 1.674% at the same time Thursday, according to Dow jones Market Data.

The 2-year Treasury note

yield rose to 0.464%, up from 0.449% a day ago, its highest such finish since March 18, 2020.

The 30-year Treasury bond yield

was at 2.091%, down from 2.127% on Thursday.

Yields rose across the curve for the week, however, with the 10-year up 8 basis points, the 2-year up 6.5 basis points and the 30-year up 4.3 basis points.

What’s driving the market?

Federal Reserve Chairman Jerome Powell warned that elevated U.S. inflation readings are likely to last into next year and that the central bank was alert to the risk that consumers start to expect higher inflation.

Powell said it was “time to taper,” a remark in line with market expectations that the Fed would announce plans to begin scaling back its program of monthly asset purchases after its early November policy meeting, given the economy is recovering and inflation is rising.

Powell’s remarks were expected to be the final word from policy makers until the next Fed meeting in two weeks. Investors have seen yields on the 2-year rise to the highest level in over 18 months and the 10-year touching heights not seen since early May this year.

In overnight trade the benchmark 10-year hit around 1.70%, FactSet data show.

Yields have been climbing over the past week as investors bet that inflation will remain elevated in the fallout from the COVID-19 pandemic, which has helped cause supply-chain bottlenecks and labor shortages as economies attempt to normalize after the 18 month long pandemic.

But a flattening of the curve may reflect worries about economic growth slowing and the possibility that the persistence of inflation may force Fed to move more aggressively than anticipated with eventual interest rate increases.

At the same time, analysts warned against reading too much into Friday’s flattening move:

In U.S. economic data, the IHS Markit flash U.S. manufacturing purchasing managers index, or PMI, dropped to 59.2 in October from 60.7 a month earlier, while the services PMI rose to 58.2 in October from 54.9. A reading of more than 50 indicates expansion in activity.

See: U.S. economy revs up a bit in October after delta speed bump, IHS finds

What analysts are saying

“Powell & Co. are in the unenviable position of executing a well-telegraphed tapering of QE at a moment when the market is far more focused on the potential for the Fed to bring forward rate hikes…It goes without saying that the higher-than-expected realized inflation profile has added a meaningful degree of urgency to the liftoff process and, as a result, the Fed needs to navigate the policy error risk of overcorrecting toward high yields only to prematurely counteract positive economic momentum,” said Ian Lyngen and Benjamin Jeffery, rates strategists at BMO Capital Markets, in a note.

“Ten year yields held the 1.7% area overnight where we believe buyers surfaced
however at some point the high yield of 1.774% will be tested
shortly as the quarter pushes on,” wrote Thomas di Galoma, managing director and head of Treasury trading at Seaport Global Holdings 

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