The Upside Down Of The Yield Curve Of US Treasuries Hit The Deepest Level in More Than 40 Years

On Thursday (February 9), the upside down of the yield of the US two-year treasury bond and the yield of the 10-year treasury bond further hit the highest level since the early 1980s, exceeding the upside down level recorded in December last year. This shows that people are increasingly questioning whether the US economy has the ability to resist further interest rate hikes by the Federal Reserve.

Market data showed that the yield of US Treasuries of all maturities rose again on Thursday, with the yield of short-term bonds ranking first. The yield of the two-year US bond, which is most closely related to the change of the Federal Reserve's interest rate, rose 6.3 basis points to 4.488%, breaking the 4.50% mark for the first time since November 30 last year.

In terms of other term yields, the yield of five-year US bonds rose 7.3 basis points to 3.864% on Thursday, the yield of 10-year US bonds rose 4.9 basis points to 3.665%, and the yield of 30-year US bonds rose 5.9 basis points to 3.731%.

At the moment of the deepest upside down in the overnight session, the yield of two-year US bonds was nearly 86 basis points higher than that of 10-year US bonds. At the end of the New York session, the upside down range of this crucial yield curve narrowed slightly to 82.3 basis points.

Previously, the stronger-than-expected employment data for January on Friday triggered a reassessment of how much the Fed's policy interest rate might need to increase to curb inflation, which is the main reason for the increase in the upside down of the US bond yield curve.

At present, the interest rate swap contract has pushed the pricing of the US federal funds interest rate peak to more than 5.1%, which indicates that the Federal Reserve will raise the interest rate to at least 5% - 5.25% in the middle of this year. This week, in the Overnight Secured Financing Rate (SOFR) option market, traders set up large positions to bet that the Federal Reserve would raise interest rates to 6% in September this year.

The data released on Thursday showed that the number of initial jobless claims in the United States rose for the first time in six weeks, but it was still at a historical low, highlighting that the U.S. employment market remained resilient despite the increased uncertainty facing the economy. Data showed that the number of people applying for unemployment benefits for the first time increased by 13000 to 196000 in the week ending February 4. The median forecast of economists surveyed was 190000.

The chairman of the Richmond Fed, Barkin, also stressed again on Thursday that the Fed needs to "stick to the end" in fighting inflation. He pointed out that it was crucial for the Federal Reserve to continue to raise interest rates to ensure that the inflation rate returned to the target level of 2%.

Will the hanging upside down continue to deepen?

In the bond market, the abnormal phenomenon that the yield of short-term bonds is higher than that of long-term bonds is known as the upside down of the yield curve, which is usually regarded as the precursor of economic recession. This phenomenon often occurs in the process of the central bank raising the policy interest rate, because this operation will push up the yield of short-term bonds, and at the same time, it will exert pressure on the yield of long-term bonds by restraining inflation and economic growth expectations.

In the history of the United States, the economy tends to fall into recession within 12 to 18 months after the upside down of the yield curve. The first inversion of the 2-year/10-year yield curve in the current cycle of the Federal Reserve's interest rate increase occurred at the end of March last year, and has been in the state of inversion for a long time since July last year.

Gregory Faranello, head of U.S. interest rate trading and strategy at AmeriVet Securities, said, "Since the Federal Reserve began this round of tightening policy, the trend has been to flatten the yield curve and increase the upside down. From the chart, nothing shows us that the upside down will not deepen further."

At the beginning of the 1980s, when Volcker, the then chairman of the Federal Reserve, significantly tightened monetary policy to curb high inflation (130.53, - 1.64, - 1.24%), the upside down of the two-year/10-year yield curve once reached a level of more than 200 basis points.

It is worth mentioning that an extremely hawkish market person overnight even believed that the traders who bet on the Fed to raise interest rates to 6% this week still set their target too low. Dominique Dwor-Frecaut, a senior market strategist at Macro Hive, a research firm, said that the Federal Reserve would have to raise the federal funds rate to about 8% in order to win the battle and completely control inflation. She reached this conclusion after analyzing the data since 1970 with the help of Taylor rule model.

Dwor-Frecaut pointed out, "If my judgment on inflation and the policy interest rate of the Federal Reserve is correct, it will have a huge impact on the market. I think it is possible to have a much deeper inversion. The yield of two-year US bonds will rise sharply - more than 6% will be easy."

Looking ahead, the next fundamental event with the greatest impact on interest rates and bond market pricing will undoubtedly be the US January CPI data released next Tuesday (February 14), from which market participants will carefully look for evidence of whether the inflation rate can further slow down.

Faranello said that the January US CPI to be released on February 14 may have a decisive impact on the US bond yield curve.