U.S. Treasury yields tumbled on Friday and the benchmark 10-year note fell the most since COVID-19 roiled markets in March 2020, as investors priced in the likelihood the Federal Reserve will force inflation down to near its target rate.
The breakeven rate on longer-dated inflation-protected bonds, which measures the difference with the yield on nominal Treasury debt, fell to nine-month lows. The yield on 10-year notes tumbled 23.3 basis points from the open to the session's lowest point, before paring the decline, to be down 7.4 basis points at 2.900%.
The two-year yield, which typically moves in step with interest rate expectations, slid 8.4 basis points to 2.843%. Both the two-year and 10-year yields were at roughly four-week lows. The breakeven rates on five- and 10-year Treasury Inflation-Protected Securities, or TIPS, slid to 2.634% and 2.361%, respectively, a level last seen in September 2021.
"The breakeven market, the difference between TIPS versus regular Treasuries, is dramatically downward sloping. It's barely above the Fed's long-term average [inflation] target of 2%," said Nancy Davis, managing partner and chief investment officer at Quadratic Capital Management LLC in Greenwich, Connecticut. "The market is pricing that the Fed's hiking rates is going to dramatically bring down future CPI inflation," she said.
Uncertainty about when inflation will peak and how deep and long a potential recession will be is driving all security markets, whether credit or equities, said Dec Mullarkey, managing director of investment strategy and asset allocation at SLC Management in Boston.
"Central banks are saying the biggest threat out there is inflation and we're going do whatever it takes to get that under control," Mullarkey said. "That's the message that the markets have priced into their securities. They're saying, 'There's a lot of risk, there's a lot of volatility.'"
The gap between yields on two- and 10-year Treasury notes , seen as an indicator of a potential recession when the short end of the yield curve inverts and rises above the long end, was at 5.6 basis points. 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 2.364%.
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