US Treasuries: the bear flattening will continue.
War. That's the focus of the week as markets were left in disarray on Friday after the White House warned that a Russian attack on Ukraine could happen any day. The Nasdaq fell by -2.78%, while the S&P dropped by -1.9%. US Treasury yields dropped across maturities sending the critical message that investors still see the US safe-haven as a refuge in case of war. That adds a key piece to the puzzle when considering future yield curve developments as it implies that the long part of the yield curve will remain compressed. Still, short-term yields will continue to adjust to the Fed's aggressive stance against inflation growth.
Indeed, a war might add to inflation concerns as Russia is a significant producer of oil, natural gas, and palladium. If the west imposed sanctions, energy price pressures would exacerbate, forcing the Federal Reserve to tighten the economy further. With the 2s10 and 5s30s spreads around 40bps, it isn’t bizarre to envision an inversion of the yield curve, which could further strangle growth.
The yield curve’s belly is already signaling an inversion. The 7s10s year spread inverted last week, while the 5s10s spread trades in the single digits and could invert any day. An inversion in the belly of the curve doesn't indicate an imminent recession; it simply suggests that the Fed is behind the curve and that the market is preparing for a severe rate hiking cycle. Things will be different when the 2s10s spread approaches the single-digit, indicating that aggressive hiking and possibly war are weighing on growth. Nevertheless, we are far from that as the economy is still forecasted to expand above trend this year.
Investors' focus has turned on the March FOMC meeting and whether the Fed will deliver a 50bps rate hike in light of last week's higher-than-expected CPI reading. If the central bank disappoints expectations, that could be a sign the Fed is not serious enough in fighting inflation. Hence, markets will consider even a more aggressive tightening plan in the future, increasing the chances of a tantrum. That's why we believe that the chances of a 50bps rate hike in March are becoming increasingly more likely.
Hence, this week’s Fed's official speeches will be in the spotlight, primarily because Fed's voting members will deliver the majority of them. Inflation data will also be in focus with the PPI numbers coming out tomorrow and retail sales on Wednesday. In terms of US Treasury auctions, there will be a 20-year bond sale on Wednesday and a 30-year TIPS sale on Thursday.