Treasury yields, breakevens fall as fears shift to recession vs. inflation

Jul. 01, 2022 11:52 AM ETD.R. Horton, Inc. (DHI), LEN, TOL, PHMBy: Liz Kiesche, SA News Editor5 Comments

Government bonds

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Investors are rushing to the safety of U.S. Treasurys after a weaker-than-expected ISM Manufacturing reading for June stokes fears of a recession, pushing aside concerns of inflation. The rush to Treasurys is leading to a dramatic drop in yields.

Two-year Treasury yield is sinking 10 basis points to 2.829% in midday Friday trading (NY time) and the 10-year yield is down 9 basis points to 2.878%; earlier the 10Y yield fell to as low as 2.798%.

While traders are still pricing in a 75-basis point rate hike at the Fed's July meeting, the probability for a 50-bp hike has increased to 28.8% vs. 17.4% a day earlier, according to the CME FedWatch tool. Based on swaps pricing, the federal funds rate is now expected to peak at below 3.4% in Q1 2023.

With the increased risk of recession, markets are pricing in lower expectations of inflation. Breakevens, which are derived from inflation-linked bonds, have dropped all around the globe, pointed out Bloomberg Opinion's John Authers. Instead, weakening economic growth has become investors' biggest concern, he contends.

Evercore ISI's Ed Hyman agrees that inflation fears have moderated, noting that over the past three months, the five-year breakeven inflation expectations have declined more than 100 bps. Meanwhile, copper has declined to 358 from 480, he said.

Note that on Thursday, the Atlanta Fed's GDPNow model for Q2 was revised to -1.0%, which indicated that the U.S. could already be in a technical recession after Q1 GDP declined 1.6%. Hyman, though, sees three reasons why the U.S. isn't in a recession — employment is too strong, the Evercore ISI's company surveys are too high and the BAA spread is too narrow to be in a recession.

With the lower inflation expectations, and thus the prospect of lower interest rates, homebuilder stocks are rising. PulteGroup (NYSE:PHM) shares are rising 4.4%, Toll Brothers (NYSE:TOL) +4.7%, Lennar (NYSE:LEN) +4.6%, D.R. Horton (NYSE:DHI) +3.6% in midday Friday trading.

On Thursday, mortgage rates reversed their upward trend, moderating to 5.70%.

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