Fidelity Says Twist in Treasury Yield Curve Has Further to Run

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Investor demand for longer-maturity Treasuries means they’re willing to accept a smaller yield premium to get the securities. Fidelity Investments says the trend has further to go.

The extra yield 10-year notes offer over two-year securities shrank to 147 basis points Tuesday, the narrowest spread in three months. The figure is less than the average of almost 2 percentage points for the past five years. A decline is known as a flattening of the yield curve.

Long-term yields have fallen over the past month as a slump in oil prices curbed the outlook for inflation. Shorter-maturity yields, which are more sensitive to what the Federal Reserve does with its main interest rate, have climbed as the central bank prepares to increase borrowing costs.

“The most likely path is for short and intermediate rates to rise modestly, while longer rates stay relatively stable,” Fidelity, the Boston-based money manager with $2.1 trillion of assets, said in a report last week. “The yield curve could flatten.”

The trend eased Wednesday, with 10-year yields climbing two basis points to 2.24 percent as of 6:30 a.m. in London, according to Bloomberg Bond Trader data. The 2.125 percent security due in May 2025 dropped 1/8, or $1.25 per $1,000 face amount, to 99. Two-year yields were little changed at 0.74 percent.

Rate Probability

There’s about a 75 percent chance the Fed will raise borrowing costs at or before its December meeting, based on the assumption that the effective federal funds rate will average 0.375 percent following the increase, data compiled by Bloomberg show.

The central bank has kept its benchmark, the target for overnight loans between banks, in a range of zero to 0.25 percent since 2008 to support the economy.

JPMorgan Chase & Co. advised investors to get out of two-year securities as the Fed gets ready to increase interest rates, in a report last week.

Crude oil has fallen 27 percent from this year’s high set in May, and bonds show investors expect deflation over the coming 12 months.

The difference between one-year U.S. yields and those for similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, was negative 0.67 percentage point. It has been below zero for two weeks.

“Oil prices are a really big problem,” said Kim Youngsung, head of overseas investment at South Korea’s Government Employees Pension Service in Seoul, which manages the equivalent of $12.8 billion. “That is why long-term interest rates are decreasing. Everybody expects the Fed to increase interest rates in the next couple of months.”

For now, signs that the Fed is moving closer to raising interest rates mean the yield curve will be one of the most highly watched metrics in the Treasury market.

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