A part of the Treasury yield curve has been inverting since Friday during the run-up to this week’s Federal Reserve’s policy decision, and traders are chalking up the development to a simple technicality.
The 7-year Treasury yield
has traded above the 10-year yield
largely because of a move known as “convexity hedging,” said Michael Franzese, a fixed income trader for MCAP. Dealers and market makers who are holding and selling mortgage-backed securities need to compensate for the risks of managing those loans by selling Treasurys when yields rise, as they have over recent days.
He called the inversion a “one-off” development that won’t necessarily spread across the rest of the Treasury curve “unless the economy stalls and/or the Fed is not prepared to stop tightening when the market thinks is sufficient.”
It’s the more widely followed spread between the 2-year
and 10-year yield
, hovering below 30 basis points as of Tuesday, that most have their eye on. A drop below zero in the 2s/10s spread is often regarded as a harbinger of a recession.
The following table shows the inversion of the 7y/10y spread, which occurred on Friday. Prior to Friday, the last time the spread had inverted was on March 9, 2020, when COVID-19 fears sent U.S. stocks plummeting. The 7y/10y hasn’t stayed consistently inverted since at least 2009, according to Derek Tang, an economist at Monetary Policy Analytics in Washington.
Source: Marketwatch
