But yields on short-term maturing bonds have accelerated their rise, closing the gap with 10-year bonds, known as ‘curve flattening’. Economic analysts often take this phenomenon as a thermometer of recessions, which is why some believe that the United States is headed for a recession.
“The flattening or inversion of the Treasury yield curve indicates that the market expects that the Federal Reserve tightening (with a rate hike that discourages consumption) will slow growth and reduce inflation in the long term”, said Kathy Jones, head of fixed income strategy at financial firm Charles Schwab’s research center.
At the close of March 22, the US 10-year bond yield, which is in inverse proportion to price, rose to 2.38%. On the same trading day, the 2-year Treasury, which is the most sensitive to changes in monetary policy, marked a yield of 2.17%, approaching the yield of long-term bonds. In fact, the spread between these yields has narrowed from 161 basis points at the start of 2022 to just 67 basis points.
However, the curve has not yet inverted, and for some economists, the flattening is a reflection of how restrictive the Federal Reserve’s monetary policy will be. For Gabriela Siller, director of financial and economic analysis at Banco Base, this flattening “implies an aggressive normalization” for the United States. It is not entirely far from what Powell evidenced of the expectations of the market itself. “I hasten to add that no one expects the soft landing to be easy in the current context…very few things are easy in the current context,” Powell said. Even the same official did not ignore the possibility of an increase in rates above 25 basis points.
Banxico in trouble
This more restrictive stance of the Federal Reserve echoes within the Bank of Mexico, and other central banks of emerging markets, as it is pressured to raise the interest rate so that the bonds are more attractive to investors, who usually seek to earn with the rate differential, in something known as the “carry trade”. In general terms, investors borrow in markets with rates close to zero to inject capital into bonds with higher yields and take advantage of that spread.
In Mexico, the interest rate was raised to 6% in the last decision made by the governing board of Banco de México (Banxico) last February. But the swap market reflects higher expectations by pegging the rate at 8.85% a year, according to central bank data as of March 22.
“The rates are going to quickly reach, in the case of Mexico, their maximum historical level since 2001,” warns Siller.