The U.S. Treasury 10-year yield touched a three-year high on Thursday and the 2 year-10 year spread widened as traders, having priced in a string of rate hikes from the U.S. central bank, have sharpened their focus on the pace and scope of the Fed's plans to reduce its balance sheet.
Fed officials "generally agreed" in their March meeting to cut up to $95 billion a month from the central bank's asset holdings as another tool in the fight against inflation, including up to $35 billion in mortgage-backed securities.
The Fed's 25 basis point rate hike last month, and market expectations for more, mostly affect the short end of the curve, while the focus on the balance sheet runoff pressures yields higher on the long end.
"This is more of the same from yesterday, the steepening of the curve, given the fact that the market is still digesting the details of the balance sheet runoff and we received quite a meaningful steepening of the curve on the back of what is considered hawkish comments from (Fed Governor Lael) Brainard, and confirmation from the minutes, that the Fed is going to be instituting an aggressive pace of balance sheet runoff," said Subadra Rajappa, head of U.S. rates strategy at Societe Generale in New York.
However, Rajappa added, "the risk is that the curve is going to continue to invert given the fact that the expectations are the Fed's going to be quite aggressive on inflation."
Brainard said on Tuesday she expects rapid reductions to the Fed's balance sheet and that the process could start in early May. Yields on the 2-, 5- and 10-year Treasuries have since hit multi-year highs, and the 2-10 yield curve went positive after having inverted late last week.
The yield on 10-year Treasury notes was up 3.8 basis points to 2.647% while the 2-year note yield was down 4.5 basis points at 2.457%, leaving the 2-10 spread at 18.72 basis points.
The near 27 basis point widening of that spread so far this week is the most for any week back to June 2013, and follows last week's 27.5 basis point tightening that inverted the curve, the sharpest weekly tightening since September 2011.
The unwinding of the recent sharp move that triggered the inversion was expected by some.
"It's really not surprising that it flattened as much as it did, but also that we're seeing some profit taking," said Tom di Galoma, managing director at Seaport Global Holdings in New York.
He said bonds will start to attract more institutional money and draw cash away from stocks when the 10-year yield climbs above 2.75%.
The yield on the 30-year Treasury bond was up 3.6 basis points to 2.668%, after touching 2.719% its highest since May 2019.
The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 3.23%, after closing at 3.232% on Wednesday.
The 10-year TIPS breakeven rate was last at 2.839% and the U.S. dollar 5-years forward inflation-linked swap , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, was last at 2.626%.
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