Yield curve flatter with all eyes on the Fed

NEW YORK: Short-dated US Treasury yields rose on Friday, flattening the yield curve, after solid data subdued investor fears of rapid economic decline in the second quarter and decreased expectations the Federal Reserve would cut rates at its meeting next week.

Retail sales increased in May, the Commerce Department reported on Friday. The pick-up in consumer spending was preceded by two weeks of weak data, including a step-down in hiring and tame inflation readings that led the market to price in at least two interest-rate cuts by the end of the year.

"The data does reinforce that the US consumer is still fairly strong. It helped the market breathe a sigh of relief that things are not deteriorating as quickly as many had anticipated," said Gennadiy Goldberg, interest rates strategist at TD Securities.

Federal Reserve Chair Jerome Powell last week said the central bank was tracking the effects of the US-China trade war on the economy, and would "act as appropriate."

The two-year yield, which moves with investor expectations of changes to interest rates, was 1.9 basis points higher to trade at 1.849%. At the long end, the 30-year yield was down 1.2 basis points to 2.590%. But across maturities moves were modest as traders held off on making big changes to positioning in advance of the Federal Open Market Committee meeting on June 18-19.

"Ahead of the Fed, this should push rates a little bit higher, but I just don't think that rates have that much more room to run given the uncertainty about what happens next week. Markets are still pricing in 25% odds of a cut in June. The odds of a dovish message coming out next week are going to keep rates contained for now," said Goldberg.

Expectations of an interest rate cut at the June meeting fell from 28.3% yesterday to 22.5% Friday according to CME Group's FedWatch tool. Expectations of a rate cut at the July meeting remain elevated at 66.8%.

"Our view is that they open the door to two cuts but they don't actually walk through it," said Goldberg.

The spread between two- and 10-year yields, a standard measure of the yield curve, narrowed to 24.2 basis points from 25.7 at the prior close.

Also on Friday, US manufacturing output rose in May, the first monthly gain this year, as an increase in the production of motor vehicles and parts countered declines in the making of metals and aerospace equipment.