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Bond Report: 2-year Treasury leads drop in yields after GDP contraction fuels expectations Fed will slow rate hikes

Treasury yields fell sharply Thursday after data showing the U.S. economy contracted in the second quarter heightened recession fears and reinforced ideas the Federal Reserve may slow the pace of rate increases a day after the central bank delivered another outsize hike.

What yields are doing

The yield on the 2-year Treasury note

was at 2.871%, down from 2.968% at 3 p.m. Eastern on Wednesday. Yields and debt prices move opposite each other.

The 10-year Treasury note yield

fell to 2.683% from 2.731% Wednesday afternoon.

The yield on the 30-year Treasury bond

was at 3.039%, up from 3.078% Thursday, up from 3% late Wednesday.

What’s driving the market

The U.S. economy shrank at an annual 0.9% rate in the second quarter, marking the second such decline for gross domestic product in a row and intensifying a debate over whether the U.S. has slipped into, or is heading toward, a recession.

Treasury yields fell Wednesday after the Fed delivered a widely expected 75 basis point increase in the fed-funds rate and signaled more hikes were on the way. Fed Chair Jerome Powell warned that the economy would need to see a period of below-trend growth to rein in red-hot inflation and warned that the path to so-called soft landing for the economy continued to narrow.

Read: Was Fed’s Powell dovish or not? 4 key takeaways from today’s press conference

Powell also said another 75 basis point rise at the Fed’s next policy meeting in September was a possibility but that the central bank would take a meeting-by-meeting approach to future moves, effectively signaling the end of a practice known as forward guidance. Future Fed moves will depend on data, he said.

The yield curve, as measured by the spread between 10- and 2-year yields, remains inverted, with the 2-year rate above the 10-year — a phenomenon that has been a reliable recession warning flag. The inversion was partially unwound after the data as the 2-year yield fell more sharply than longer-dated rates.

Fed-funds futures show traders have priced in a 76% probability of a 50 basis point hike in September and a 24% chance of a 75 basis point move, according to the CME FedWatch tool. Ahead of the GDP data, traders had priced in a 70% chance of a 50 basis point move and a 30% probability of a 75 basis point hike.

What analysts say

“Ahead of the data, the Treasury market was bull steepening and with the GDP numbers in hand we have seen that price action extend with 2s/10s above -15 basis points,” wrote Ian Lyngen and Ben Jeffery, rates strategists at BMO Capital Markets. “The growing skepticism that the Fed will continue to deliver aggressive tightening has been emboldened by this morning’s numbers and in terms of outright rates we will be watching 2.70% in 10s as GDP is traded and month-end considerations come into focus.”

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