Treasury Yield-Curve Inversion Approaches Multi-Year Extreme

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(Bloomberg) — A key segment of the US Treasury yield curve approached its most inverted level in decades Monday as traders priced in further Federal Reserve policy tightening.

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The two-year note’s yield exceeded the 10-year rate by as much as 110.8 basis points as the shorter-maturity rate reached 4.96%. The inversion touched 110.9 basis points in March, a level last seen in the early 1980s, according to data compiled by Bloomberg.

The inversion eased to around 108.5 basis points after the ISM manufacturing gauge for June unexpectedly declined to a three-year low. In a shortened trading session ahead of a US holiday, Treasury two-year yields dropped to as low as 4.84% before climbing to nearly 4.94%. The 10-year yield rose to about 3.85%.

“The near-term risks are that more rate hikes must be priced, that the Treasury curve flattens more, and that the pace of slowing both within the inflation and employment data does not satisfy policymakers and the markets,” John Brady, manging director at RJ O’Brien, wrote to clients.

The closely watched barometer of recession risk has ranged from inverted by as much as 111 basis points to as little as 27 basis points since March.

The flattening trend has gathered pace as expectations for the Fed’s path move toward pricing in a quarter-point interest-rate hike this month and another increase by year-end. Swap contracts currently price in about 22 basis points of tightening for the July 26 decision. They fully reflect an increase by September and about half of an additional boost by year-end.

Interest-rate strategists at Bank of America said in a report released Monday that positioning metrics suggest the curve “is prone to flatten further.”

The central bank left rates unchanged last month following 10 straight rate increases to assess how elevated policy rates are impacting the economy. But stronger-than-expected economic data released since then suggest additional tightening is likely.

The first major economic indicators for June are being released this week, culminating with employment data on Friday. US markets will be closed Tuesday for US Independence Day.

–With assistance from Elizabeth Stanton.

(Adds reaction to ISM Manufacturing report, updates yield levels.)

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