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Bond Report: Treasury yield curve flattest since April 2020 amid signs of imminent invasion into Ukraine by Russia

The widely followed spread between 2- and 10-year Treasury yields shrank to its narrowest level since April 2020 on Wednesday as investors continued to monitor developments in the Russia-Ukraine crisis.

The gap fell below 39 basis points, according to TradeWeb data as of Wednesday morning. Meanwhile, yields were broadly higher across the curve as investors began to factor in a less aggressive start to the Federal Reserve’s next rate-hike cycle, starting in March.

What are yields doing?

The 10-year Treasury note
TMUBMUSD10Y,
1.972%

yields 1.961%, up from 1.947% on Tuesday at 3 p.m. Eastern Time. Tuesday’s level marked its sharpest one-day rise since Feb. 15, according to Dow Jones Market Data. Yields rise as prices for debt fall.

The 2-year Treasury note rate
TMUBMUSD10Y,
1.972%

stands at 1.571%, up from 1.557% a day ago, when it put in its steepest daily rate gain since Feb. 10.

The 30-year Treasury bond
TMUBMUSD30Y,
2.263%

yields 2.254%, slightly higher from 2.253% on Tuesday afternoon.

What’s driving the market?

Investors are closely watching as Ukraine prepares for war against Russia — with Kyiv declaring a state of emergency and 190,000 Russian troops lined up along Ukraine’s borders — in what U.S. President Joe Biden has described as the beginning of an invasion by Moscow into the Eastern European country.

The geopolitical crisis has stoked concerns about war, but investors appear to also be attuned to the inflationary implications of sanctions by Western countries against Russia in response to its troop deployment into the pro-Russian Donbas region of Ukraine.

The European Union, Japan and the U.S. have all moved toward sanctioning Russia after Russian President Vladimir Putin ordered troops to breakaway regions of Ukraine. Oil futures turned solidly higher Wednesday as traders weighed the risks to global crude supplies from the crisis.

Fixed-income investors see higher energy prices as another contributor to inflationary pressures, and those pressures can chip away at the fixed value of Treasurys.

Nonetheless, fears that the Federal Reserve might need to aggressively dial up interest rate hikes in response to out-of-control inflation are easing, with traders pricing in only a 25% chance of a half-point move in March. That’s down from 41% on Tuesday, according to the CME FedWatch Tool.

Meanwhile, the so-called yield curve inched closer to inversion, with rates on 2- and 10-year Treasurys continuing to shrink. An inversion is when rates on shorter maturities outperform those of longer-dated debt, and has historically preceded a recession.

There’s no data on Wednesday but investors will be watching for an auction of $53 billion in 5-year notes
TMUBMUSD05Y,
1.886%

and a $22 billion sale in 2-year floating-rate debt.

What analysts are saying

“The whole bond market is selling off and it’s probably because there’s some decent-sized hedging going on,” as well as investors who are now factoring in gradual 25 basis point hikes from the Fed, Tom di Galoma,  managing director of Seaport Global Holdings, said via phone. “There are a lot of people who think forward curves are telling you a recession is coming, but I’m in the camp that won’t believe that until I see the spread between the 3-month and 10-year rates invert.”

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