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Bond traders’ mood turns sour as yield curves flatten all over the world

The bond market’s mood turned downcast on Wednesday as traders questioned the U.S. economy’s ability to handle a potential rise in interest rates by the Federal Reserve next year and the Treasury yield curve flattened as a result, while similar moves were seen playing out across the world.

The spread between 2- and 10-year U.S. yields narrowed to levels not seen in a month early Wednesday, according to data from Tradeweb, as long-dated yields slipped and shorter ones continued to rise. The counterpart gap between 5- and 30-year yields also narrowed to some of the flattest levels since April 2020. The moves come just a week before the Federal Reserve may announce the tapering of its $120 billion in monthly bond purchases, a prerequisite first step before lifting its policy interest rate possibly next year.

Investors are concerned that the U.S. and other developed-market economies won’t be able to handle higher interest rates to counter higher inflation unleashed by the pandemic. Flattening yield curves — in which long-term yields are either falling relative to shorter-term rates, or not climbing as fast — are also being seen in the 5- and 30-year gaps of the U.K., Germany, Italy, France, and Greece, according to Tradeweb’s data.

The pronounced global flattening of yield curves, particularly in the 5s/30s spread, included 15 basis point drops in Australia and Canada today, according to Scott Ruesterholz, a portfolio manager at New York-based Insight Investment, which manages more than $1 trillion. On Wednesday, the Bank of Canada took a major step in pulling back on the amount of stimulus it is providing to the economy, by ending its bond-buying program.

“Around the world, we are now seeing central bank pricing get pulled forward, with multiple hikes expected for Canada, Australia, and Norway,” Ruesterholz said via phone. “The market is now coming to grips with the potential for a global rate-hiking cycle beginning next year, whereby you could see the pace of tightening increase. But central banks probably don’t have to hike as much because you’ve lost some global momentum — and that’s leading to pretty pronounced flattening of the curve.”

In the U.S., the 2-year yield
TMUBMUSD02Y,
0.492%
,
which is most closely associated with expectations for near-term Fed policy moves, rose above 0.51% on Wednesday, one of the highest levels since March 2020. The 10-year yield
TMUBMUSD10Y,
1.539%

and the 30-year rate
TMUBMUSD30Y,
1.947%

are each heading for their largest one-day declines in three months, trading around 1.525% and 1.943% respectively.

Flattening yield curves are generally associated with economies losing momentum. They’re currently being taken as a warning signal that the Fed and other central banks could be tapping on the brakes of an economic recovery at a time when growth might be waning. Flatter curves are also bad for banks which lend at long-term rates but pay interest on short-term ones, and raise the specter of inverting curves, which can foreshadow a recession.

Shares of large banks like Citigroup Inc.
C,
-0.23%

and JPMorgan Chase & Co.
JPM,
-2.03%

were down Wednesday. The Dow industrials
DJIA,
-0.62%

also drifted 0.2% lower after hitting a closing record Tuesday. The S&P 500 Index SPX and tech-heavy Nasdaq Composite Index
COMP,
+0.17%

were higher, by around 0.2% and 0.8% respectively.

“The seeds of flatter yield curves globally have been planted” following a period of peak monetary stimulus globally, with the exception of China, said Jack McIntyre, who helps oversee more than $66 billion at Brandywine Global Investment Management in Philadelphia. “Central banks have started the process of withdrawing that stimulus. Some central banks have to remove it faster than others.”

Brandywine Global has been buying some developed market bonds, such as German bunds, as well as the government debt of developing markets like China, he said via phone. The firm still has a high degree of confidence in emerging market bonds, where spreads are attractive and central banks have already embarked on tightening cycles. He says Brandywine Global doesn’t currently own any Treasuries, and expects U.S. yields to move higher, but “is open to the idea that yields are not going to move significantly higher.”

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