NEW YORK, March 22 (Reuters) - The spread between the three-month Treasury bill yield and the 10-year note yield narrowed to a fresh 12-year low on Friday morning, less than 1 basis point above parity, following the Federal Reserve’s decision to cease tightening monetary policy and as soft German manufacturing data added to fears about the slowdown in global growth.
A narrower spread between the 3-month and 10-year yields indicates increased market expectations of a recession. The 3-month and 10-year spread is the Fed’s preferred measure of the Treasury yield curve as it shows the strongest historical correlation between curve inversion and a forthcoming recession.
The spread flattened to August 2007 lows on Thursday, then flattened to fresh lows on Friday. It was last at 0.76 basis point and could continue to flatten to inversion if the 10-year yield continues its downward trajectory. The yield curve inverts when spreads fall below zero basis points.
The 10-year yield broke below the psychologically significant 2.5 percent level, and was last at 2.471 percent, its lowest since January 2018. The fall in the 10-year also weighed on the spread between 2- and 10-year yields , another significant measure of the yield curve. That spread was last at 10.5 basis points, still above December 2018 lows.
Nearly every portion of the yield curve was flattening on Friday morning, said Guy LeBas, chief income strategist at Janney Montgomery Scott. “That reflects expectations slowing economic growth and a potential recession in 2020. All that is pretty clear.”
On Wednesday, the Fed issued a statement showing policy-makers foresaw no further interest rate hikes for 2019 given the slowdown in the American economy, and forecast just one hike through 2021. In a major shift, it no longer anticipates the need to guard against inflation with restrictive monetary policy. It also said it would halt the steady decline of its balance sheet in September.
“The Federal Reserve wants the curve to steepen. A bull steepener - meaning front rates come down and long rates go up - would signal both that the markets are accepting their dovish approach and that it will reflate the economy. That’s not happening,” said LeBas.
“Essentially the curve is telling us that what the Fed has done so far is not sufficient to reflate the economy.”
German manufacturing contracted further in March, a survey showed on Friday, compounding fears that unresolved trade disputes are exacerbating a slowdown in Europe’s biggest economy. That added to worries about global growth, with slowdowns seen across Europe and in China, and dragged the benchmark German 10-year bund yield below zero for the first time since 2016. (Reporting by Kate Duguid; editing by Jonathan Oatis)