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Wednesday’s U.S. June inflation data produced welcome relief for investors, taking pressure off a deeply inverted Treasury yield curve for now.
The 2-year rate
TMUBMUSD02Y,
finished the New York session 88 basis points above the 10-year yield
TMUBMUSD10Y,
— producing one of the least negative spreads in about a month. The 2s10s spread had been at more than minus 100 basis points as recently as last week, and was minus 92.96 basis points early Wednesday before the June consumer price index came out.
Wednesday’s CPI data contained the lowest annual headline rate since 2021, at 3% — giving investors and traders a taste of the long-awaited decline in inflation they had been hoping for.
As stock investors cheered the report, traders aggressively bought U.S. government debt, which pushed yields lower across the board. Shorter-term rates like the 2-year yield fell the most, as traders factored in the likelihood that the Federal Reserve might deliver just one more quarter-of-a-percentage-point rate hike on July 26.
A less negative 2s/10s spread reflects “a less sky-is-falling type of messaging,” said Bryce Doty, senior vice president and senior portfolio manager at Sit Investment Associates in Minneapolis. “It bolsters confidence when the curve isn’t so inverted because people view it as such an albatross, a sign of disaster. As that signaling dissipates, all of a sudden it’s like a dark cloud disappearing.”
The 2s/10s spread is considered to be one of the bond market’s most reliable indicators of approaching U.S. recessions, though it’s not so good at pinpointing the exact start of such downturns. A negative spread typically signifies pessimism about the outlook in the market, while a positive spread reflects greater optimism. The 2s/10s spread has remained consistently below zero since July of last year.
Read: Bond-market recession gauge plunges further into triple digits below zero after reaching four-decade milestone
Negative Treasury yield spreads impact the business models of banks which loan money out over a long term, by borrowing from customers’ deposits. Therefore, “overall lower inflation and lower interest rates is exactly what all banks need to put them on more solid footing right now,” said Doty, whose team manages $9 billion in assets.
In addition, he said via phone, “a year from now, yields will probably be lower and if you are a bond investor you should probably increase duration now and lock in yields while you can before they drop.”
On Wednesday, the 2-year Treasury yield finished at 4.74%, or lowest level in two weeks, while the 10-year rate ended at 3.86%. Meanwhile, all three major U.S. stock indexes
DJIA,
SPX,
COMP,
closed higher and the U.S. Dollar Index
DXY,
which moves in conjunction with expectations on U.S. rates, was down by 1.2%.
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