The US Bond Yield Curve flattens amidst expectations of the aggressive Fed policy

The implications of flattening spread between 10-year and 2-year Treasury bond yields.

The US Bond Yield Curve flattens amidst expectations of the aggressive Fed policy

The yield spread between 10-year and 2-year Treasury bond yields have been steadily eroding over the year, sliding down to 0.4 percent points on February 18, 2022. from 1.6 percent points on March 22, 2021. This can be traced from the attached chart of the US Treasury bond yield spread.

For the first time since 2019, the yield on the benchmark ten-year US Treasury bond has gone up above 2% as the past week’s report showed that US inflation hit 7% in December.

2-10 Spread

Economists tend to watch the 2- year and 10-year bonds' yield spread because that is one of the most reliable recession indicators.

Usually, investors require higher yields for bonds with longer maturities. The US two-year Treasury pays less than 1.6%, compared with 2% for the ten-year. However, over the past year yields of short-term Treasury bonds have been rising faster compared to longer-dated government bond yields rises that have moved at a slower pace. Hence the gap between the yield on short- and long-duration bonds has been flattening.

When yield curves flatten, it can raise concerns about whether there is a recession on the horizon. A significant flattening in key parts of the U.S. Treasury yield curve reflects investors' concerns that the Federal Reserve might have been too slow to raise interest rates or would introduce rate hikes too rapidly to catch up with the high inflation, which may cause a recession.

Nevertheless, it appears that at this point yield curve inversions are still far away, and a lot will depend on how aggressive the Fed tightening policy will turn out.

Thus, Bank of America projects 7 hikes, one at every meeting in 2022 plus 4 more in 2023. That would bring the Fed Funds Rate at 2.75% to 3.00% at the end of 2023. Deutsche Bank and Wells Fargo predict 5 rate hikes this year and 3 more in 2023, which would put the Fed Funds Rate at 2.0% this year and 2.25% at the end of 2023. UBS and Barclays expect 3 rate increases. What will actually happen yet remains to be seen.

Stay tuned with Wolfline Capital, and we will share with you more interesting news and insights.

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