3 Numbers: Will The U.S. Yield Curve Continue To Flatten?

 | Jun 19, 2017 06:16AM ET

  • The benchmark 10-year Treasury yield fell last week despite another Fed rate hike
  • The Reuters Tankan Index should reaffirm the outlook for a recovery for Japan
  • Japan’s third-longest postwar expansion could become its second-longest
  • The Mexican peso reached a 13-month high against the US dollar last week

    • Softer inflation data seems to be weighing on the US 10-year Treasury yield, despite last week’s decision by the USD/MXN will remain topical as the Mexican peso’s strong recovery this year against the US dollar rolls on.

    US: 10-Year yield: The Fed explained last week’s rate hike as a decision grounded in upbeat economic expectations. But the benchmark 10-year Treasury isn’t convinced.

    Thanks to the central bank, the short end of the yield curve remains at or near the highest levels since the recession ended in mid-2009. The long end of the curve, by contrast, remains relatively depressed. As a result, the yield curve has become increasingly flat this year.

    At last week’s close, the 10-year/two-year spread, for instance, settled at 84 basis points, close to a seven-month low. The relatively thin spread suggests that the Treasury market is expecting slow-to-modest growth and softer-than-expected inflation. If the spread inverts at some point and the two-year yield exceeds the 10-year rate, that would be a signal that the crowd’s pricing in elevated odds of a recession.

    Economic growth is still the likely path for the near term, but the crowd has turned cautious, according to Treasuries. Will the wary sentiment continue to squeeze the yield spread? The economic schedule is light this week and so yields may stick to a narrow range in the days ahead until economic data gives the market new guidance.

    Meantime, traders will continue to digest the Fed’s decision to raise rates despite the recent slowdown in inflation. The annual pace of consumer price inflation in May fell below the Fed’s 2% target for the first time in six months. According to some analysts, that’s a recipe for an even flatter curve.

    “The fact that the Fed is tightening against the backdrop of slowing inflation implies that the market continues to price in policy error,” the head of US rates strategy at Citigroup advised last week.