The gap between 2-year and 30-year yields has narrowed to 63 basis points from 83 since Oct. 1, as long bonds rallied while Fed hike expectations pinned the front end. The Treasury sells 20-year bonds on Wednesday, the maturity that now yields more than the 30-year.
Since the first trading day of October, the two ends of the Treasury curve have gone different ways.
The 30-year Treasury yield closed Tuesday at 5.42%, according to Treasury data, down 19 basis points from 5.61% on Oct. 1. The 10-year closed at 5.12%, down 12 basis points over the same span. The 2-year, the maturity most sensitive to Federal Reserve expectations, closed at 4.79%, a single basis point above its Oct. 1 level.
The result is a flatter curve. The spread between 2-year and 30-year yields has narrowed to 63 basis points from 83 on Oct. 1. The spread between 2-year and 10-year yields has narrowed to 33 basis points from 46.
Tuesday in miniature
Tuesday repeated that pattern in a single session. The 30-year fell 6 basis points, the 10-year 3 and the 2-year rose 2, while oil eased from a five-month high and weak housing data showed pending home sales down 7.3% in September.
The front end has a clear anchor. In a poll of 100 economists released on Tuesday, every one expected the Fed to raise rates in December, and 94 expected no change at next week's meeting. With a December increase so widely expected, there is little room for 2-year yields to fall.
The long end has more to work with. Oil has come off its highs at times since Oct. 1, housing has weakened, and a central bank that is still tightening into an energy shock raises the odds of slower growth later.
A kink in the curve
One part of the curve does not fit a simple shape. The 20-year yield closed Tuesday at 5.47%, five basis points above the 30-year. It has yielded more than the 30-year on every day of October. That makes Wednesday's 1 p.m. auction of 20-year bonds a direct test of demand at the one maturity that pays more than the longest bond.
Market implications
One reading is that the bond market is pricing a Fed that tightens into weakness. A pinned front end and falling long yields are what investors would expect if they believe higher short rates now will slow the economy and inflation later.
A second reading is that the long-end rally is fragile because it leaned on oil. Brent was back above $110 early Wednesday as Tehran hardened its terms for talks with Washington, and a sustained move higher in crude would push inflation expectations, and long yields, back up.
The 20-year auction will help separate the two. Strong demand at a yield above the 30-year would support the first reading; a weak sale would suggest the long end's gains since Oct. 1 are vulnerable.
What to watch
Wednesday's 20-year auction results; weekly jobless claims on Thursday, with forecasts near 200,000; the Fed's decision on Oct. 28; oil; and the 2-year to 30-year spread. A spread back above 70 basis points would show the flattening reversing.