(Bloomberg) — A crucial part of the US Treasury yield curve risks inverting even more to a level last seen in the early 1980s as the economy inches closer to a recession, according to Allspring Global Investments.
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Two-year yields are likely to surge in the next six months, increasing the inversion with 10-year yields to at least 100 basis points, said Brian Jacobsen, senior investment strategist at the firm. The yield gap at that part of the curve stood at minus 44 basis points on Friday, the deepest in a month, data compiled by Bloomberg show.
The sharper increase in two-year note yields relative to longer-maturity Treasury yields underscores increasing concern about how much further the Federal Reserve will have to hike interest rates to tame inflation. Other key parts of the curve are also moving further into negative territory, indicating heightened concerns among investors about a contraction in economic growth.
“As we begin to see the market price in the reality that the Fed wants to hike and hold at a fairly high rate, let’s say something close to 4.25%, maybe 4.5% for the Fed funds rate come March, we expect that the two-year Treasury should probably reflect that type of reality,” Jacobsen said in an interview on Bloomberg Television.
In that scenario, two-year yields may rise to between 4% and 4.5%, while those for the 10-year are likely to fall to 3%, resulting in an inversion “which we haven’t seen basically since the 1980s,” Jacobsen said.
Allspring Global was formerly known as Wells Fargo Asset Management and had $476 billion of assets under management as of June 30.
This section of the US curve dropped to more than 200 basis points below zero in the early 1980s, when then Fed Chairman Paul Volcker hiked interest rates to 20% to combat annual inflation which reached a peak of 14.8%.
Markets are expecting the FOMC to deliver a 75-basis-point hike in its meeting next week and the Fed rate to peak at around 4.5% in March from a current range of 2.25%-2.5%.
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Allspring will be paying close attention to the Fed’s language next week, as it expects further pain ahead.
“It’s not necessarily what they’ll do, but what they’ll say that is really worrying to us,” Jacobsen said.
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