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Post: Bond Report: Treasury yields drop by most since June on signs of slowing U.S. economy, Biden’s positive COVID test

Treasury yields posted their biggest declines of the past three to five weeks on Thursday, reversing course from earlier in the day, after traders assessed signs of a slowing U.S. economy and President Joe Biden tested positive for COVID.

The drop in yields was led by the 3-year maturity, which captures expectations for the Federal Reserve’s intermediate-term policy path.

What happened
  • The yield on the 2-year Treasury

    declined 15.3 basis points to 3.095% from 3.248% late Wednesday afternoon. That’s the largest one-day decline in the yield since June 15, based on 3 p.m. levels, according to Dow Jones Market Data.

  • The yield on the 10-year Treasury

    slumped 12.7 basis points to 2.908% from 3.035% in the previous session. That’s the yield’s biggest drop since June 22.

  • The yield on the 30-year Treasury

    dropped 9.7 basis points to 3.071% from 3.168% on Wednesday. That’s the biggest drop since June 29.

The 10-year to 2-year spread of minus 18 basis points means the Treasury curve remains meaningfully inverted, suggest an economic downturn is on the horizon.

What’s driving markets

U.S. data released on Thursday showed weekly initial jobless claims rising to 251,000, up from the previous week’s 244,000 and above forecasts of 240,000. Meanwhile, the Philadelphia Fed’s gauge of regional business activity contracted in July for a second straight month, and the U.S. leading economic index is pointing to recession around the end of the year.

See: Almost all the economic numbers line up: A U.S. recession is likely

Traders were still assessing the data when a White House spokeswoman confirmed that Biden tested positive for COVID-19 and is experiencing “very mild symptoms.”

Expectations for Federal Reserve policy shifted toward greater conviction in a three-quarters of a percentage point rate hike. Markets are pricing in a 73% probability that the Fed will raise interest rates by another 75 basis points, to a range of 2.25% to 2.5%, at its July 26-27. The chance of a 100 basis point hike was 27%. The central bank is mostly expected to take its borrowing costs to around 3.5% to 3.75% by February 2023, according to fed funds futures trading as shown in the CME FedWatch Tool.

See: The Fed could get lucky or things might go wrong. A guide to where the economy might go from here

Overseas, the European Central Bank increased interest rates by 50 basis points. The move from negative rates to zero was the first rate hike in eleven years, was double the size that had been forecast, and comes as the ECB struggles to contain eurozone inflation at a record high of 8.6%.

Meanwhile, worries about a savage economic slowdown in Germany have receded after Russia resumed natural gas flows through the Nord Stream 1 pipeline on Thursday. However, the flow is expected to be less than full capacity, creating an uncertain outlook.

Italian benchmark bond yields BX:TMBMKIT-10Y jumped after Prime Minister Mario Draghi resigned in response to members of his governing coalition refusing to back him in a no-confidence vote, resulting in the president calling new parliamentary elections.

The yield spread with Germany, a closely watched gauge of stress for Rome’s debt, rose to 223 basis points during European trading hours, as doubts grew that Italy could fulfill conditions necessary to receive its €200 billion ($204 billion) share of the EU’s coronavirus recovery fund.

What strategists are saying

“The outlook for the world economy has darkened again and we have reduced our forecasts for all major economies, leaving them further below the consensus of economists,” according to the global economics team at Capital Economics.

“We now anticipate recessions in the euro-zone and the UK and expect the US, Canada and Australia to avoid economic contraction only narrowly,” the team wrote. “If a technical `global recession’ is avoided, this will be largely thanks to a moderate post-COVID rebound in China and relative economic strength among the major commodities producers. Inflation is likely to prove more persistent than in the recent past, so the widespread and aggressive monetary policy tightening cycle has further to run. But this will add to headwinds to growth and ultimately force several central banks to reverse course in 2024 or even before.”

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