yield curve

Yield Curve May Steepen to Record as Recession Favors Two-Years

By Dakin Campbell and Liz Capo McCormick

Nov. 10 (Bloomberg) — Treasury two-year notes, the worst performing U.S. government securities in the past year, may beat longer-term debt as the Federal Reserve cuts interest rates to pull the U.S. economy out of a nosedive, according to one of the bond market’s most-watched barometers.

The difference between yields on two- and 10-year notes, known as the yield curve, may widen to a record 3 percentage points from 2.46 percentage points now, according to strategists at Morgan Stanley and Credit Suisse Group AG. Shorter-term yields are falling on expectations the Fed will reduce its target for overnight loans between banks to curtail the recession. Ten-year yields are likely to rise as the government borrows to bail out the U.S. financial system, they said.

Two-year notes returned about 2.3 percentage points more than 10-year securities as the yield curve reached its record of 2.74 percentage points in August 2003 and the Fed finished a series of 13 rate reductions. Historically, the gap is steepest as the central bank stops cutting and investors anticipate an economic recovery, according to Tony Crescenzi, chief bond- market strategist at Miller Tabak & Co. LLC in New York.

“As we get into the teeth of this slowdown toward the end, you will see the yield curve steeply sloped,” said Francis Mustaro, a money manager in New York at J&W Seligman & Co., which oversees about $15 billion. “It’s classic.”

Crescenzi, author of “The Strategic Bond Investor,” wrote that the yield curve “is the closest thing the bond market has to a crystal ball.”

`More Than Compelling’

Treasuries gained 8 percent the past year as the credit crunch sent the economy toward a recession and investors sought the safety of government debt, according to data compiled by Merrill Lynch & Co. Two-year notes gained 7.47 percent, lagging behind the 8.21 percent return for 10-year debt.

The U.S. economy contracted at a 0.3 percent pace in the third quarter, and economists surveyed by Bloomberg forecast it will shrink 0.8 percent through the end of the year.

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