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Why Bond Markets Returned to Worrying about Flattening Yield Curve

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Inflation miss triggers yield curve flattening worries

The US bond markets moved marginally higher in the previous week as investors’ worry about rising bond yields fell after the February inflation print showed stable growth. The Consumer Price Index (or CPI) grew by 0.2% in February, taking the annual growth in core inflation to 1.8%. The bond market responded to the inflation report with a fall in bond yields after the inflation report. Weaker-than-expected housing starts and building permits have also added to the downward pressure on the bond yields last week. The Vanguard Total Bond Market (BND) ETF, which tracks the performance of the bond markets, ended the previous week at 79.5, appreciating by 0.26% for the week ending March 16.

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Bond market performance and speculator positions

For the week ending March 16, the ten-year (IEF) yield closed at 2.8%, depreciating by five basis points. The two-year yield (SHY) closed at 2.3% (up by three basis points), and the longer-term 30-year yield (TLT) closed at 3.1% (down by nine basis points). The decline in long-term yields reignited the fears of yield curve flattening, which is a negative signal for the economy.

As per the latest commitment of traders (or COT) report, released on March 16 by the Chicago Futures Trading Commission (or CFTC), speculator short positions decreased for the first time in four weeks. The total net bearish positions as of Tuesday, March 13, fell by 90,781 contracts from 362,150 contracts to 271,369 contracts. Stable inflation growth in February allayed bond market investors’ fears about interest rates increasing too quickly, resulting in a decrease in short positions in the US bond (BSV) markets.

The week ahead for the bond markets     

This week, the focus of bond market investors will likely be on the FOMC meeting. It is highly expected the Fed will increase rates by 0.25% at this meeting, but the focus will be on the language of the statement, which could push bond yields either way. Bond market bulls might be hoping for a dovish Fed, which could lead to lower yields and higher bond prices, while bond bears might be hoping for an unambiguously hawkish Fed, which could increase the odds for a fourth rate hike in 2018 and thereby push bond yields higher and bond prices lower.

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