A closely watched signal of recession risk in Treasury markets on Wednesday hit its most extreme level in more than 20 years, as hotter than expected inflation data fuelled investor bets that the Federal Reserve will aggressively raise interest rates.
The yield on the two-year Treasury note, which is particularly sensitive to short-term rate expectations, rose 0.09 percentage points to 3.13 per cent after data showed the annual rate of US consumer price inflation hit 9.1 per cent last month. Yields rise when prices fall.
At the same time, the yield on the benchmark 10-year note fell 0.05 percentage points to 2.91 per cent. The two-year yield has been higher than the 10-year yield since last week, known as an inverted yield curve, a phenomenon that has preceded every recession for the past 50 years.
Wednesday’s move brought the spread between the two to its most inverted level since 2000.
The unexpectedly high US inflation figure — economists had forecast a rate of 8.8 per cent — increased pressure on the Federal Reserve to raise interest rates by at least 0.75 percentage points at its next policy meeting later this month.
“While our base case remains for a [0.75 percentage point] hike from the Fed in July, we cannot rule out the possibility of a larger [1 percentage point] hike or additional [0.75 percentage point] hikes beyond this month,” analysts at Citi said in a research note.
“The acceleration of the monetary cycle is not yet behind us, and we will have to wait until 2023 to see the Fed consider a pause,” said Florian Ielpo, head of macro at Lombard Odier Investment Managers.
But Marco Pirondini, head of US equities at Amundi, said inflation was likely to peak over the summer, following recent falls in oil and commodity prices in response to weak recent manufacturing and consumer surveys.
“Towards the end of the year, inflation numbers will start to look a lot better than now, so [the Fed] will have more space to balance inflation and growth,” he said.
The US central bank’s main policy rate sits in a target range of 1.5-1.75 per cent. Following the inflation reading, futures markets showed investors expect the rate to rise rapidly to 3.65 per cent by the end of this year before reversing next year as the Fed cuts rates to combat any economic slowdown.
Wall Street’s benchmark S&P 500 dropped as much as 1.4 per cent in response to the inflation data, before clawing back some of its losses to close 0.4 per cent lower. The Nasdaq Composite slipped 0.2 per cent.
In currency markets, the euro dropped briefly below parity with the dollar for the first time in two decades following the hot inflation report. The dollar index, which measures the US currency against six others and which hit a 20-year high on Tuesday, inched back 0.1 per cent.
While many analysts are predicting a US recession in response to financial conditions tightening, fears of an economic slowdown are more intense in Europe, where governments are facing up to the prospect of Russia cutting gas supplies.
The Stoxx Europe 600 share index — which has fallen 15 per cent this year in a broad global stock downturn driven by big central banks raising interest rates — closed 1 per cent lower. London’s FTSE 100 fell 0.7 per cent.
Brent crude, the international oil benchmark, regained 0.1 per cent to $99.57 a barrel after slumping in the previous session on concerns about new coronavirus lockdowns in China.
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