The Tell: Traders raise expectations for accelerated rate hikes by Federal Reserve after Powell speaks, flattening Treasury curve even further

Dan Kitwood/Getty ImagesThe spread between yields on 2- and 10-year Treasury notes, one of the most closely watched parts of the yield curve, narrowed Tuesday to a level not seen since January, while traders boosted their expectations for an accelerated pace of rate hikes by the Federal Reserve following an unexpected hawkish pivot by Chairman Jerome Powell.The odds of a 25 basis point rate hike in March went up to roughly 26% from 18% a day ago, while the likelihood of one by May is now around 38% versus 30% on Monday, according to the CME’s FedWatch Tool. Traders also factored in a 21% chance of two hikes by June, up from 14% a day ago.Powell’s remarks about the need to consider a faster pace of tapering bond purchases in December amid the risk of higher inflation led to a further flattening of the Treasury yield curve, in which the differential between short- and long-term yields shrank as traders factored in a greater likelihood of rate hikes within the next two years, as well as a diminished long-term outlook. The widely followed spread between 2- and 10-year yields was already showing signs of “breaking down” before the Fed chairman testified on Tuesday, and appeared poised to resume its downward trend as a result of the flight-to-safety trade triggered by the omicron variant of the coronavirus, according to Joe Kalish, chief global macro strategist at Ned Davis Research, a firm whose clients include institutional investors.Read:Why investors should care about falling global bond yields and a flattening Treasurys curve”We define `breaking down’ as breaking support and not going back to its peak” of 159 basis points reached in March, Kalish said, in a phone interview. “We’ve had significant flattening already and there are indications that there’s still another phase to go,” considering long-term U.S. yields like the 10-year are higher than other developed countries and continue to attract buyers.  For months, bond rates world-wide have been on a steady, downward trend — accompanied by flattening yield curves that suggest investors expect global economic growth to slow, inflation to eventually moderate, or both. The dynamics are worrisome because lower yields end up punishing savers, while rewarding risk-takers who borrow. What’s more, a flatter curve, or shrinking differential between yields of various maturities, reduces incentives for banks to make longer-term loans like mortgages or car loans.SVB Financial Group SIVB and Comerica Inc. CMA are just a few of the financial companies whose stocks fell on Tuesday.The spread between 2- BX:TMUBMUSD02Yand 10-year yields BX:TMUBMUSD10Y is often regarded as a sign of investor sentiment about the economic outlook. On Tuesday, that spread continued to flatten to as low as 91 basis points after Powell spoke — breaking through a key support level of 98 basis points seen as likely to accelerate the flattening trend, according to Kalish. Stocks extended declines after Powell’s comments, with the Dow Jones Industrial Average DJIA down more than 600 points for a 1.8% loss, while the S&P 500 SPX and Nasdaq Composite COMP each dropped 1.7%.

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