Treasury Yields Continue Dropping

Treasury yields plunged again as investors flocked to safe-haven assets after the banking chaos. They are scaling back the likelihood of another rate hike this month from the Federal Reserve.

The yield on the benchmark 10-Year U.S. Treasury Note fell 26 basis points from 3.70% to 3.44% while that on the 2-year T-note declined by 74 basis points. The yield curve inversion is shrinking rapidly, with the spread between the 2-year and 10-year yields now at -41 basis points vs -90 basis points just two weeks ago. Yet it does not mean recession risks are behind us. The paradigm has shifted with the shutdown of SVB and the regional bank failure. Even if it does not result in a systemic risk, recession risks - sooner rather than later - have picked up as a sharp pullback in bank lending is looming. Small banks facing “deposit flight” could be forced to deleverage, sell assets and cut back on new lending.

The flight to quality did not reverberate through all the investment grade segments. Investment grade corporate bond prices were down 0.22% in Europe (IBOXX € Liquid Corporates index) even though the yield on the German 10-year Bund was down 40 basis points to 2.11%. They were up 0.55% in the U.S. (IBOXX Ishares $ Investment Grade Corporate Bond Index) for the third week in a row. If investors still expect the SVB crisis may lead to a less aggressive Fed next week, their optimism has been dampened on the other side of the Atlantic. On Thursday, the European Central Bank raised interest rates by 50 basis points, ignoring worries about the Credit Suisse turmoil. It is likely that the Governing Council was aware of the takeover of Credit Suisse, deeming that “the euro area banking sector is resilient, with strong capital and liquidity positions. In any case, the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed”.

High-yield bonds slid 0.98% in Europe (IBOXX € Liquid High Yield Index) and edged down 0.12% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index). Lastly, emerging debt in local currencies lost 0.32%.