© . FILE PHOTO: A security guard walks in front of a picture of the Federal Reserve after the Federal Open Market Committee’s (FOMC) two-day policy meeting in Washington, March 16, 2016. REUTERS/Kevin Lamarque By Davide Barbuscia NEW YORK () – Sharp moves in US government bond markets are increasingly pointing to the risk of an impending recession, with “bond vigilantes coming out of the woodwork” and markets questioning the US Federal Reserve’s plan to bring about a “soft landing” for the economy as it is raising interest rates to fight inflation, market experts said. Fed Chair Jerome Powell said Monday that the US central bank must act “quickly” to rein in excess inflation and could use more-than-usual rate hikes if necessary. Bond yields, which move inversely to prices, spiked as the US Treasury yield curve continued its flattening trend. “The market appears to be questioning the soft landing view for the US economy that the Fed advocated at its March FOMC meeting,” said BofA strategists. The US Treasury yield curve reflects “recession risks, and not just from the extreme flatness of the curve at the start of the Fed’s tightening cycle,” the strategists said. The closely followed part of the yield curve, measured between 10-year and 2-year Treasuries, has narrowed about 60 basis points since the start of the year, with longer-dated bonds now yielding less than 20 basis points more than two years of debt. Any inversion of that part of the curve, with shorter notes yielding more than longer ones, is generally seen as a precursor to a six-to-24 month recession. “The yield curve looks ominous,” wrote Christopher Murphy, Co-Head of Derivatives Strategy at Susquehanna Financial Group, although he said an inversion doesn’t always guarantee a recession. Melissa Brown, Global Head of Applied Research at Qontigo, said the yield curve reflects a shift in market perceptions about the Fed’s ability to tighten monetary policy just enough to curb inflation without sending the economy into recession. “The market may be assuming they can’t thread that needle… it’s going to be hard not to drive us into a recession,” she said. Still, Powell said Monday he saw no increased likelihood of a recession in the coming year and others are skeptical of such an event. That prompted Fed interest rate futures on Monday to increase the likelihood of a half-percentage-point tightening at the next policy meeting in May. Analysts at NatWest said Powell clearly “warned about risks of a 50 basis point rise in upcoming meetings,” which they said would send Treasuries into “free fall.” When asked Monday about concerns about what the yield curve is saying, Powell said he focused on the short end of the curve, i.e. the first 18 months of maturities. Morgan Stanley (NYSE:) said in a research note Sunday that a yield curve inversion in the second quarter of this year was possible, but that an inversion does not necessarily anticipate a recession. “It does, however, support our view of severely slowing earnings growth,” the report said. For Tim Holland, chief investment advisor at Orion Advisor Solutions, a recession is not imminent despite the flat curve. Another part of the curve, which compares three-month bills to 10-year bonds, has steepened this year, from 145 basis points on December 31 to 181.54 basis points on Monday. “If the past 30 years is any guideline, both parts of the curve have to flatten and reverse before we run the risk of a recession,” he said. Powell’s speech Monday at a National Association for Business Economics conference caught some market participants by surprise for appearing more aggressive than his comments after the Fed hiked Federal Funds interest rates by 25 basis points last Wednesday. Yields rose on the 10-year benchmark note on Monday to a return of 2.298%, from 2.153% on Friday – the highest since May 2019. Two-year government bond yields, which better reflect monetary policy expectations, rose from 2.111% on Monday. 1.942% on Friday. “What you saw today is that Powell is actually throwing in the towel, he said he’ll do whatever it takes, and it’s kind of won the market back,” said Andrew Brenner, head of international fixed income at National Alliance Securities. . Brenner described the behavior of the bond market as that of vigilantes — when investors push for high yields to offset inflation risk. “Bond vigilantes have come out of the woods,” Brenner said, adding that he saw a large amount of sales in the futures market, particularly concentrated in five-year futures.
