Fed's Powell Flattens Yield Curve as 2-Year Hits Highest in Decade

The U.S. two-year Treasury yield rose on Tuesday to its highest level in nearly a decade, with the yield curve at its flattest in nearly 11 years, as Federal Reserve Chairman Jerome Powell's upbeat remarks on the economy supported traders' view of more rate hikes.

Powell, in testimony about the economy and monetary policy before a Senate panel, said: "With appropriate monetary policy, the job market will remain strong and inflation will stay near 2 percent over the next several years."

Powell downplayed the current friction between the Trump administration and major U.S. trade partners as a risk to business and consumer activities.

"The move is just short-term yields leaking higher as the market is pricing in more Treasury bill supply and more rate hikes," said Justin Lederer, Treasury strategist at Cantor Fitzgerald in New York. "The market is quite content with where long-term yields are."

The spread between two-year and 10-year Treasury yields was 24.10 basis points, hovering at its tightest level since July 2007.

Interest rates futures implied traders saw about an 89-percent chance the Fed would lift its target range on key interest rates by a quarter point, to between 2.00 percent and 2.25 percent, at its Sept. 25-26 policy meeting, CME Group's FedWatch program showed.

They suggested traders priced in about a 63-percent likelihood of another rate hike at the Fed's Dec. 18-19 policy meeting.

Signs of a slight pick-up in business and consumer activities in the second quarter had stoked bets the Fed may consider a faster pace of rate hikes. But the consensus view remained that the Fed would refrain from turning more aggressive on hiking rates to avert inverting the yield curve.

"Right now, with the Fed’s gradual rate increases, he will continue with that approach," said Paula Solanes, portfolio manager at SVB Asset Management in San Francisco.

An inverted yield curve, in which short-dated Treasury yields rise above long-dated ones, has preceded the past five U.S. recessions. After his appearance in front of the Senate Banking Committee, Powell will complete his semiannual testimony before the House Financial Services Committee at 10 a.m. (1400 GMT) on Wednesday.

On light trading volume, the yield on benchmark 10-year Treasury notes was 2.860 percent, up 0.4 basis point from Monday. The two-year yield, which is most sensitive to traders' views on changes in Fed policy, hit 2.615 percent, the highest since August 2008, according to Reuters data.