Yield curve recession signal strengthens as war fuels ‘stagflation’ fears

A view shows a destroyed school building in Zhytomyr
A Ukrainian service member walks by near a school building that was destroyed by shelling in Zhytomyr, Ukraine, March 4, 2022 as Russia’s invasion of Ukraine continues. REUTERS/Viacheslav Ratynskyi

March 6, 2022

By Davide Barbuscia

NEW YORK (Reuters) – Recession concerns are becoming more evident in the US Treasury yield curve as rising commodity prices in the wake of Russia’s invasion of Ukraine fuel concerns about inflation and slowing growth.

The closely-watched gap between two- and ten-year bond yields was at its narrowest since March 2020 on Friday, a signal some investors may be expecting economic growth to slow from its current robust pace.

On a rolling two-month basis, the flattening of the 2s/10s was the most extreme since 2011, said Jonathan Cohn, Credit Suisse’s head of rates trading strategy.

Market participants watch the yield curve for insights into the US economy. An inverted curve, in which interest rates on short-term government debt are higher than those on longer-term debt, has reliably predicted previous recessions.

Investors said the latest moves appear to be driven by concerns that prices for oil and other commodities, which have soared after commodity-exporting giant Russia invaded Ukraine, will fuel already high inflation, the Fed said will force interest rates to rise even more when growth slows.

While expectations of a 50 basis point hike this month have been all but priced out in recent weeks, markets still expect over 150 basis point tightening by next February. [FEDWATCH]

“If central banks prioritize fighting inflation in 2022 after failing the world on that front in 2021, then moving into a stagflationary environment likely means they will have to accept some kind of recession to clean up the whole mess.” , said Jeffrey Halley, senior market analyst, Asia Pacific, at OANDA, citing a mix of weak growth and strong inflation.

Brent crude oil prices on Thursday approached $120 a barrel, the highest since 2012, after a fresh round of US sanctions targeting Russia’s oil refining sector and raising concerns that oil and gas exports will be hit next could become.

At the same time, growth appears strong for now: the US unemployment rate fell to a two-year low of 3.8% in February, the Labor Department’s closely-watched jobs report showed on Friday, raising optimism that the economy is facing mounting geopolitical headwinds could withstand tensions, inflation and tighter monetary policy.

However, the flattening of the curve suggests this may not last.

“The flattening has accelerated as the Fed appears to prioritize inflation moderation over risk appetite containment,” said Credit Suisse’s Cohn.

(Reporting by Davide Barbuscia in New York, editing by Matthew Lewis) Yield curve recession signal strengthens as war fuels ‘stagflation’ fears

Caroline Bleakley

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