NEW YORK: Treasury yields at the long end drifted lower on Friday after data on labor costs and wage growth suggested inflation remains sticky and raised fears of a recession as the Federal Reserve seeks to cool the economy without sparking a sharp slowdown.
The Employment Cost Index increased 1.3% last quarter, with labor costs rising 5.1% on a year-on-year basis, the Labor Department reported, while wages and salaries shot up 1.4% in the second quarter and were up 5.3% year-on-year.
“The markets are pricing in a recession and they seem to be doing it fairly quickly,” said Tom di Galoma, managing director at Seaport Global Holdings in Greenwich, Connecticut. “Everybody fears that inflation is a lot worse and yields will rise again at some point.”
The yield on benchmark 10-year Treasury notes slid 5.7 basis points to 2.624%, a drop from a high of 2.845% at the beginning of the week.
The drop in yields put the 10-year on track to fall 33 basis points in July, the largest monthly decline since March 2020.
The spread between two- and 10-year Treasury yields, a closely watched part of the yield curve as it can signal a recession when the short end is higher than the long, was at -26.6 basis points, widening from -14.70 earlier.
The two-year US Treasury yield, which typically moves in step with interest rate expectations, rose 1.1 basis points at 2.889%.
The 10-year TIPS breakeven rate, a gauge of inflation expectations, rose to 2.528%, indicating the market sees inflation averaging about 2.5% a year for the next decade. Earlier in the week it suggested inflation of 2.4%.
“The market is now pricing rate cuts into 2023, betting that the Fed will have to step in as the growth outlook deteriorates,” said Mauricio Agudelo, head of fixed income at Homestead Advisors in Arlington, Virginia. “We expect the yield curve to remain inverted and the removal of forward guidance by the Fed will add to market volatility for the balance of the year.”
The Commerce Department reported the second straight quarterly decline in gross domestic product on Thursday, as consumer spending grew at its slowest pace in two years and business spending declined.
The Fed on Wednesday raised the federal funds rate by 75 basis points for the second time in two months, but many investors perceive inflation to be on the mend and will keep the US central bank from aggressively tightening policy.
Evidence suggests inflation is on the mend and a recession, if there is one, will be short and shallow, said Russell Price, chief economist at Ameriprise Financial in Troy, Michigan.
However, consumers may be in for a surprise when they see energy bills this winter as the US exports more natural gas, mostly to Europe, to offset lower Russian supplies, he said.
“We believe US prices could see further upside given that global natural gas prices are much higher than domestic rates,” Price said in a note.
The yield on the 30-year notes fell 7.8 basis points to 2.961%.
The breakeven rate on five-year US Treasury Inflation-Protected Securities (TIPS) was last at 2.768%.
The US dollar 5 years forward inflation-linked swap, seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed’s quantitative easing, was last at 2.533%.
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