Bond Report: Treasury yields drop by most since June on signs of slowing U.S. economy, Biden’s positive COVID test

Treasury yields moved lower Thursday morning, reversing course from earlier in the day, after traders assessed signs of a slowing U.S. economy and President Joe Biden tested positive for COVID.

The drop in yields was led by the 3-year maturity, which captures expectations for the Federal Reserve’s intermediate-term policy path.

What’s happening

The yield on the 2-year Treasury

fell to 3.158% from 3.248% late Wednesday afternoon.

The yield on the 10-year Treasury

slumped to 2.932% from 3.035%in the previous session.

The yield on the 30-year Treasury

dropped to 3.076% from 3.168% on Wednesday.

The 10-year to 2-year spread of minus 22 basis points means the Treasury curve remains meaningfully inverted, suggest an economic downturn is on the horizon.

What’s driving markets

U.S. data released on Thursday showed weekly initial jobless claims rising to 251,000, up from the previous week’s 244,000 and above forecasts of 240,000. Meanwhile, the Philadelphia Fed’s gauge of regional business activity contracted in July for a second straight month, and the U.S. leading economic index is pointing to recession around the end of the year.

See: Almost all the economic numbers line up: A U.S. recession is likely

Traders were still assessing the data when a White House spokeswoman confirmed that Biden tested positive for COVID-19 and is experiencing “very mild symptoms.”

Expectations for Federal Reserve policy shifted toward greater conviction in a three-quarters of a percentage point rate hike. Markets are pricing in a 73% probability that the Fed will raise interest rates by another 75 basis points, to a range of 2.25% to 2.5%, at its July 26-27. The chance of a 100 basis point hike was 27%. The central bank is mostly expected to take its borrowing costs to around 3.5% to 3.75% by February 2023, according to fed funds futures trading as shown in the CME FedWatch Tool.

See: How high will the Fed have to push up interest rates to cool down inflation? No one knows

Overseas, the European Central Bank increased interest rates by 50 basis points. The move from negative rates to zero was the first rate hike in more than a decade, was double the size that had been forecast, and comes as the ECB struggles to contain eurozone inflation at a record high of 8.6%.

Meanwhile, worries about a savage economic slowdown in Germany have receded after Russia resumed natural gas flows through the Nord Stream 1 pipeline on Thursday. However, the flow is expected to be less than full capacity, creating an uncertain outlook.

Italian benchmark bond yields BX:TMBMKIT-10Y jumped after Prime Minister Mario Draghi resigned in response to members of his governing coalition refusing to back him in a no-confidence vote.

The yield spread with Germany, a closely watched gauge of stress for Rome’s debt, rose to 223 basis points during European trading hours, as doubts grew that Italy could fulfill conditions necessary to receive its €200 billion ($204 billion) share of the EU’s coronavirus recovery fund.

Thursday’s sudden drop in Treasury yields sent the 10-year rate back below 3%.

What strategists are saying

Thursday’s data suggests that “economic activity is slowing and the Fed might not have to be as aggressive,” Scott Buchta, head of fixed income strategy at Brean Capital, said via phone.

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