In the US, the stock market continues to reach new highs, and the cryptocurrency market signals strength, while the bond market tells a different story. This week, the yield on short-term US Treasury bonds increased faster than that of long-term bonds. As of May 24, 2-year Treasury notes provided 47.9 basis points more yield than 10-year Treasury notes, marking the year’s most significant difference. The inversion of the yield curve, where short-term yields exceed long-term yields, historically indicates tougher economic times ahead. Notably, the current inversion is the longest in US history, with no signs of reversing soon.
Fed’s Impact on Treasury Yields
Fed‘s recent actions have significantly impacted short-term yields. Fed officials’ statements have dashed hopes for a rate cut in the summer, and expectations of prolonged high rates due to ongoing inflation control and strong unemployment data have pushed the 2-year yield close to 5%. This has deepened the inversion of the yield curve, reflecting investors’ concerns about the economic outlook.
Two main factors contribute to the deeper inversion of the yield curve. First, the weakening economic outlook prompts investors to secure current yields by taking on long-term debt, anticipating future rate cuts. Second, the Fed’s actions and mixed recent economic data have caused the 2-year yield to rise faster than the 10-year yield.
Expectations of Economic Slowdown
Meanwhile, investors’ expectations of an economic slowdown could lead to future rate cuts and encourage them to invest in long-term debt now to benefit from current yields. This behavior has significantly inverted the yield curve, a traditional signal of potential economic downturns.
Starting in June, the Federal Open Market Committee (FOMC) will allow $25 billion of its bonds to mature monthly without reinvestment. This will increase the amount of Fed money flowing into the Treasury market, potentially raising prices and lowering yields. According to New York Fed data, 34% of the Fed’s Treasury holdings have maturities of 10 years or longer.
Next week’s Treasury auctions are critical as they could significantly impact market trends. These auctions are closely watched for indicators of investor sentiment and potential changes in the yield curve.
