US bond market fireworks after Powell speech highlights recession worries

NEW YORK (REUTERS) - The US bond market was hammered anew on Monday (March 21), with a sell-off driving yields on short-dated Treasuries to one of their biggest daily jumps of the past decade after Federal Reserve chair Jerome Powell said he's willing to enact larger hikes if needed to fight inflation.

The sharp moves in the US Treasury market are increasingly pointing to the risk of an approaching recession, with "bond vigilantes coming out of the woodwork" and markets doubting the Fed's plan to engineer a "soft landing" for the economy as it hikes rates to fight inflation, market experts said.

"The market seems to be challenging the soft-landing view for the US economy that the Fed argued at the March FOMC meeting", BofA (Bank of America) strategists said.

The US Treasury yield curve reflects "recession risks, and not just through the curve's extreme flatness at the inception of the Fed tightening cycle", the strategists said.

Mr Powell's speech on Monday at a National Association for Business Economics conference caught some market participants off guard as they seemed more hawkish than his remarks after the Fed last Wednesday raised the federal funds rate by 25 basis points.

Yields spiked on Monday with the 10-year benchmark note up to a yield of 2.298 per cent from 2.153 per cent on Friday - the highest since May 2019. Yields of two-year Treasuries, which more closely reflect monetary policy expectations, jumped to 2.111 per cent from 1.942 per cent on Friday.

The closely followed part of the yield curve measured between 10-year and two-year Treasuries has narrowed by about 60 basis points since the start of the year, with the longer-dated notes now yielding less than 20 basis points more than two-year debt.

Any inversion of that part of the curve, when shorter notes yield more than longer ones, is generally seen as presaging a recession by six to 24 months.

"The yield curve does look ominous," wrote Mr Christopher Murphy, co-head of Derivatives Strategy at Susquehanna Financial Group, although he said an inversion does not always guarantee a recession.

Ms Melissa Brown, global head of Applied Research at Qontigo, said the yield curve is reflecting a shift in market views on the ability of the Fed to tighten monetary policy just enough to reduce inflation without throwing the economy into a recession.

"The market perhaps is assuming that they can't thread that needle... it's going to be tough to not drive us into recession", she said.

Still, Mr Powell on Monday said he did not see an elevated likelihood of a recession in the next year and others are skeptical of such an event.

Analysts at NatWest said Mr Powell was clearly "warning of risks to 50bp hike(s) at the coming meetings", which they said sent Treasuries into "free fall."

When asked on Monday about concerns on what the yield curve is saying, Mr Powell said that he focused on the short end of the curve, meaning the first 18 months of maturities.

Morgan Stanley said in a research note on Sunday that an inversion of the yield curve was possible in the second quarter this year, but that an inversion does not necessarily anticipate a recession.

"However, it does support our view for sharply decelerating earnings growth", it said.

For Mr Tim Holland, chief investment adviser at Orion Advisor Solutions, a recession is not imminent, despite the flat curve.

Another part of the curve which compares three-month bills with 10-year notes has steepened this year, from 145 basis points on Dec 31 to 181.54 basis points on Monday.

"If the past 30 years is any guide, both parts of the curve need to flatten and invert before we are at risk of recession", he said.