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Bond Report: 10-year Treasury yield falls to lowest in two weeks, flattening the curve, even as Fed official sees need to quickly raise interest rates next year

The 10-year Treasury yield fell to its lowest level in two weeks on Friday, flattening the curve as the two-year rate rose but still booked its biggest weekly drop in more than a month, following a busy period for major central banks.

The widely followed spread between 2- and 10-year yields narrowed toward the lowest level this year, as a week packed with moves by major central banks drew to a close. The 2s-10s spread shrank to 75.8 basis points and the gap between the 5- and 30-year rates narrowed to 63.8 basis points, according to Tradeweb data.

What are yields doing?

The 10-year Treasury note TMUBMUSD10Y, 1.409% yield fell 2.1 basis points to 1.401%, down from 1.422% at 3 p.m. Eastern on Thursday. Yields and debt prices move opposite each other. The yield reached its lowest level since Dec. 3 on Friday and fell 8.6 basis points this week, based on 3 p.m. levels, according to Dow Jones Market Data.
The 2-year Treasury yield TMUBMUSD02Y, 0.641% rose 2.1 basis points to 0.640%, up from 0.619% Thursday afternoon. It still fell 2 basis points this week, the largest one-week decline since the period that ended Nov. 5.
The yield on the 30-year Treasury bond TMUBMUSD30Y, 1.822% fell 4.4 basis points to 1.816%, down from 1.86%. The yield fell 6.7 basis points this week, and is down six of the past eight weeks.

What’s driving the market?

Friday’s bond-market moves were likely the result of some combination of year-end fund rebalancing needs, illiquidity around the holidays, and worries that central banks may be tightening monetary policy into a weaker global economic environment. Those concerns are enhanced by uncertainty over the economic implications of the spread of the omicron variant of the coronavirus that causes COVID-19.

Earlier in the day, Federal Reserve Bank of New York President John Williams told CNBC that the decline in yields at the long end appeared to be driven largely by COVID-related news. Williams also said he’s confident the central bank can stabilize inflation without a recession.

Fed officials are planning to end bond purchases by March, much faster than previously expected, and have penciled in three rate increases for 2022.

In a speech Friday afternoon, Fed Gov. Christopher Waller said the central bank should quickly start to raise its benchmark interest-rate target next year given “alarmingly high” inflation readings. “I believe an increase in the target range for the federal funds rate will be warranted shortly after our asset purchases end,” Waller said in remarks to the Forecasters Club of New York.

Overseas, the Bank of Japan said on Friday that it would begin unwinding some of the emergency stimulus measures put in place due to the COVID-19 pandemic, starting in April. But the bank stuck with its ultra-easy stance on monetary policy, by maintaining its targets for short-term interest rates at minus 0.1% and the 10-year Japanese government bond yield at around zero.

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On Thursday, the Bank of England surprised markets by lifting its key benchmark by 15 basis points to 0.25%, becoming the first major central bank to raise interest rates. The European Central Bank, meanwhile, affirmed it would end its emergency program of asset purchases in March, while temporarily boosting the size of a longer-running asset-buying program beginning in the second quarter of next year.

Read: ECB to end emergency pandemic asset buys in March, while Bank of England delivers ‘Super Thursday’ surprise

What are analysts saying?

“If the bond market is telling me anything, it’s two things: that investors don’t buy into the inflation story and they think Fed rate hikes will slow growth,” said Dan Eye, head of asset allocation and equity research at Fort Pitt Capital Group. “The bond market is willing to look through the inflation numbers we are seeing now and into the future — and it is expecting a dramatic decline at some point. I don’t know how else to expain 1.4% on the 10-year.

“The flattening curve is also telling us this interest-rate hike cycle is going to be pretty shallow,” Eye said via phone.

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