вЂњThe yield curve is saying that the Fed is going to hike us right into recession.

вЂњBy inverting the yield curve the Fed is going to create a credit crisis again,вЂќ said Nancy Davis, founder of Quadratic Capital Management. Given that the CPI historically has run about 40 basis points above the inflation metric the Fed targets - the personal consumption expenditures price index - breakevens signal the US central bank will be able to drive inflation back near its 2 per centВ target, albeit at a considerable toll. The five-year breakeven rate, representing bond tradersвЂ™ expectation for the average CPI rate over the period, is hovering around 2.5 per cent, down from a record high of about 3.8 per centВ in March. At the same time, bond-market proxies of expected inflation have tumbled, underscoring expectations for slower growth. Such thinking was evident in the strong investor demand for a 30-year bond sale on Wednesday, when the securities were sold at a yield below the market level ahead of the sale. вЂњAs a bond manager we are forward-looking,вЂќ and if the economy does weaken from вЂњcentral banks overdoing their tightening,вЂќ he said Western would increase its overweight position in 20- to 30-year Treasuries. вЂњCentral banks are kicking into a higher gear, and as growth slows the hope is that a policy mistake is not made,вЂќ said Mark Lindbloom, portfolio manager at Western Asset Management, referring to the risk that central banks overshoot and excessively slow growth. Such contracts on Thursday dialled back expectations of a full-point increase this month, a step the Bank of Canada took on Wednesday. Swap prices reflect a consensus that the Fed will enact rate hikes of at least three-quarters of a percentage point in both July and September. The scale of the move will depend on how far the Fed needs to push up its main rate. In 1980, the gap widened to as much as minus 2.4 percentage points. In 2000, 10-year yields dipped as much as 56 basis points below those on 2-year notes. The key question is whether the degree of the yield curveвЂ™s inversion will mirror 2000 or the much larger moves in the early 1980s, when the FedвЂ™s efforts to rein in an inflationary surge set off back-to-back recessions. Markets have since repriced both ends of the equation, seeing the overnight rate peaking at 3.7 per centВ in December, followed by more than 70 basis points of cuts next year. WallerВ saidВ he could support more aggressive action if warranted by upcoming retail sales and housing data.Д«efore the latest inflation data, the bond market was already pricing in more than 60 basis points of rate cuts by the end of 2023 after the FedвЂ™s benchmark peaked around 3.30 per cent. Louis Fed President James Bullard both backed a three-quarter point hike this month. There was some tempering of the inversion trade on Thursday, when the 10-year yield moved back to within 17 basis points of the two-year note after Fed Governor Christopher Waller and St. вЂњThe yield curve is probably telling us something serious now.вЂќ вЂњThe Fed really has missed the ball on inflation and letting it get entrenched, so 100 basis points is definitely on the table,вЂќ said John Luke Tyner, portfolio manager at Aptus Capital Advisors, which oversees US$2 billion in assets. The diverging paths have driven 10-year yields as much as 28 basis points below 2-year ones, the most since 2000, in the wake of the dot-com stock bubbleвЂ™s collapse. That was apparent Wednesday, when long-term Treasuries rallied in the wake of the consumer price index while short-term bonds slid. The lengths the central bank is likely to go to tame inflation has left investors pouring into wagers on longer-term bonds, anticipating the securities will outperform if the nation lapses into a recession. That would be the biggest increase since the Fed started directly using the overnight rate to conduct monetary policy in 1990s, raising the risk that growth will stall as higher interest rates hit the economy.

The jump in consumer prices in June by anotherВ four-decade highВ reinforced the near-certainty that the Federal Reserve will keep tightening monetary policy aggressively, with markets placing mounting odds on a full-percentage-point hike this month. For all the volatility whipsawing the US bond market, traders are showing increasing confidence that the alarm bells warning of a recession will only get louder.

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