Treasuries extended their rise on Friday as fresh data on the U.S. manufacturing sector stoked fears that the Federal Reserve’s rate hikes could lead to a recession.
Benchmark yields fell across the curve, with belly and short yields leading and the five-year rate at one point plummeting more than a quarter of a percentage point to 2.78%. The closely watched 5-30 year yield curve spread widened by more than 10 basis points on the day. Benchmark yields closed their lows, with the five-year rate at 2.88%, in a shortened session ahead of the Independence Day long weekend.
The bond market was already rallying sharply across the curve on recession fears before the Institute for Supply Management’s manufacturing gauge fell more than expected in May to 53, while new orders and employment are fell below a reading of 50, entering contraction territory. The magnitude of the shift in yields and the curve was exacerbated by low liquidity ahead of the bank holiday weekend. Technical factors also played a part, with the 10-year yield crossing its 50-day moving average for the first time in a month.
“These are big moves and it reflects the combination of limited liquidity and more evidence that this economy is slowing down,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “That’s what the Fed wants to see and the debate at their July meeting will be 50 or 75” basis point hikes. “The Fed isn’t looking to slow down, so the initial rally should run out of steam.”
The 10-year note faces a tough barrier around 2.72%, but a weak jobs report at the end of next week would “further fuel the bond market rally,” Faranello said. The 10-year yield closed 13 basis points lower at 2.88%, after falling to 2.79%.
This prospect of weaker data and a growing potential for recession has fueled demand for protection, with traders paying the most since March to protect against a deeper drop in 10-year Treasury yields.
The latest decline in yields was accompanied by dated Fed swap contracts pricing in further tightening of around 173 basis points at the central bank’s December meeting, down 11 basis points from the closing Thursday. The change in the price of the Fed’s policy trajectory swaps saw the market reduce expectations for a peak rate to around 3.3% from over 4% last month as the end of central bank tightening was advanced from mid-2023 to approximately February.
“Terminal rate pricing has collapsed,” said William O’Donnell, managing director of rate office strategy at Citigroup Inc. “More inflation is now good news for the bond market because it means more Fed tightening that increases the risk of a recession.”
Traders raised the prospect of rate cuts next year, with the spread between Eurodollar rate futures on December 2022 and 2023 contracts reversing to -75.5 basis points Friday, and that spread has moved nearly 50 basis points from a peak on Tuesday. .
The latest leg of the global bond market recovery gathered pace after Fed Chairman Jerome Powell said on Wednesday that the risk of hurting the economy from higher rates was less important than the recovery of price stability.
The outlook for a recession in the United States improved on Thursday after figures showed personal spending for May rose 0.2%, half the expected increase. The purchases price index increased by 0.6% against 0.7% expected, confirming the hypothesis of an inflation peak being established.
Market-implied inflation expectations have steadily declined, along with nominal yields, over the past three weeks. Among them, the five-year forward estimate of the expected five-year inflation rate briefly dipped below 2% earlier on Friday, where it last traded in February before climbing to 2.6. % in April. The Fed is targeting an average inflation rate of 2% over time. The US bond market’s shift to pricing recession risk is emulating the world. In Australia, the three-year yield fell 21 basis points, just days before its central bank announced a half-point rate hike, while European yields also fell.
Germany’s two-year bond posted its biggest weekly trading range since 2008 as the market bets quickly on the European Central Bank’s rate hike.
The stock’s yield — the most sensitive to shifts in political expectations — more than halved, falling from a high of 1% on Tuesday to as low as nearly 0.40% on Friday. Traders are bracing for around 140 basis points of hikes this year, up from no less than 190 basis points on June 16, with the price revision spurred by speculation that inflation in the region is showing early signs of cooling.