U.S. Yield Curve Steepens as Yellen Hints Economy May Run Hot

  • Yields on 10-, 30-year Treasuries climb to highest since June
  • Measure of inflation expectations rises to five-month high

The Treasury yield curve steepened, with the gap between five- and 30-year debt widening by the most since March, as Federal Reserve Chair Janet Yellen cited “plausible ways” that running the U.S. economy hot could repair damage caused to growth trends by the Great Recession.

U.S. 30-year yields surged to the highest since June after Yellen pondered in the text of a speech to a Boston Fed conference whether a “high-pressure economy” could boost areas like labor-force participation. A bond-market gauge of inflation expectations known as the break-even rate climbed to the highest level since May.

Traders are scouring data for signs that the U.S. economy is strong enough to warrant an interest-rate increase. Yellen’s remarks come two days after minutes of the Fed’s September policy committee meeting showed “several” of the majority who supported the decision to hold rates steady said it was a “close call.”

"She talks about the merit in letting the economy run hot temporarily -- that is dovish," said Priya Misra, head of global interest-rate strategy in New York at TD Securities (USA) LLC, one of 23 primary dealers that trade with the central bank. “The Fed seems to be in the midst of a debate about undershooting on the unemployment rates -- Yellen seems to be more in the camp advocating for the undershooting. That should argue for a steepener and higher inflation risk premiums."

Yield Curve

The benchmark 10-year note yield rose six basis points, or 0.06 percentage point, to 1.8 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data, the highest closing level since June 2. U.S. 30-year yields climbed eight basis points to 2.56 percent, also the highest since June 2.

The difference between yields on five- and 30-year debt, a gauge of the yield curve, climbed to about 1.27 percentage points, the highest in a month.

“Increased business sales would almost certainly raise the productive capacity of the economy by encouraging additional capital spending,” Yellen said in the speech text. “A tight labor market might draw in potential workers who would otherwise sit on the sidelines.”

Data released Friday showed U.S. retail sales climbed in September by the most in three months, while a University of Michigan consumer sentiment index dropped to a one-year low.

Inflation Expectations

“Most of what she’s said is consistent with her past statements -- it’s certainly dovish, but she’s been dovish in the past,” said Aaron Kohli, a fixed-income strategist at BMO Capital Markets Corp. in New York, a primary dealer. “The steepening is certainly entrenched, something that we expect to continue. The data is very lukewarm, and that’s the backdrop.”

In a sign traders are preparing for inflation to accelerate, the 10-year break-even rate, which measures the difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, rose to about 1.68 percentage points.

Fed fund futures indicate the probability of a rate increase by the FOMC’s December meeting is about 69 percent, up from 50 percent on Sept. 27. The calculations assume that the effective fed funds rate will average 0.625 percent after the next increase.

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