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Bond Report: Long dated U.S. Treasury yields see biggest declines since July as traders question if U.S. can handle higher interest rates

Long-dated Treasury yields posted their biggest one-day declines in more than three months amid souring sentiment in the bond market, in which traders questioned whether the economy can handle higher interest rates possibly starting next year.

Flattening yield curves from the U.S. to the U.K. and Australia were seen as a warning that many economies may run into trouble as central banks worldwide pivot toward tighter monetary policy.

What are yields doing?

The yield on the 10-year Treasury note

fell nine basis points to 1.528%, the lowest level in almost two weeks and down from 1.618% at 3 p.m. Eastern on Tuesday.

The 2-year note yield

rose 10 basis points to 0.491%, another 52-week high, compared with 0.448% late Tuesday and temporarily traded above 0.51% on Wednesday. It’s the highest level for the yield since March 18, 2020, based on 3 p.m. levels, according to Dow Jones Market Data.

The yield on the 30-year Treasury bond

declined 11 basis points to 1.942%, the lowest level since Sept. 23, from 2.051% late Tuesday.

It was the biggest one-day declines for the 10- and 30-year yields since July 19.

What’s driving the market?

The flattening of the yield curve — a line plotting yields across all Treasury maturities — came amid central banks’ efforts worldwide to tighten policy as their economies recover from the coronavirus pandemic.

The market moves came as investors weighed the possible timing of the first policy interest rate increase by the Federal Reserve since December 2017 and the trajectory of subsequent hikes. The rise in shorter term yields reflected expectations for the start of the next rate-hiking cycle possibly next year, once the Fed completes the tapering of its monthly bond purchases. The Fed is widely expected to announce its plan to begin the tapering process at its policy meeting on Nov. 2-3.

After rising in recent months, longer-dated yields have lagged behind increases at the short end though, a sign that the economy may be losing momentum and/or the rate-hike cycle may prove to be relatively short.

Similar flattening moves have played out across the world — from Australia and Canada to France, Germany, Greece, Italy, and the U.K. as the market’s mood darkened.

Read: Bond traders’ mood turns sour as yield curves flatten all over the world

Data released Wednesday showed U.S. durable-goods orders declining 0.4% in September, with much of the weakness in autos and aircraft, while the trade deficit in goods widened 9.2% to a record $96.3 billion last month.

Meanwhile, Wednesday’s sale of $61 billion in five-year notes was “very solid” and produced “a strong result,” according to BMO Capital Markets strategist Ben Jeffery.

Investors will be looking ahead to other economic data this week, such as Thursday’s release of gross domestic product data for the third quarter.

What are analysts saying?

“More aggressive rate hike assumptions have potentially negative consequences: some fear those rate hikes could dampen the recovery,” said Bill Merz head of fixed-income research at U.S. Bank Wealth Management in Minneapolis.

 “With relatively aggressive rate hikes being priced in, we have to ask the question, ‘Why?’ The answer is inflation and it’s not necessarily the kind of inflation based on strong demand, but rather supply-chain problems and worker shortages,” Merz said via phone. “In that kind of environment, aggressive rate hikes currently being priced in begin to jeopardize the recovery in late 2022 and 2023, which impacts long-term bond yields today.”

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