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Bond Market Back on Inversion Watch as Fed Split Clouds Outlook

Katherine Greifeld

(Bloomberg) -- A closely watched section of the U.S. yield curve flattened after Federal Reserve policy makers delivered an as-expected quarter-point rate cut, but were split over the need for further easing.

The spread between 2- and 10-year Treasury yields narrowed to around 2 basis points at the day’s low, the flattest level in a week, after the Fed’s updated projections -- known as the dot plot -- showed that five officials wanted to leave rates unchanged.

That dissent over the future path of monetary policy pushed up short-term yields, given that they are especially sensitive to Fed expectations, according to Seema Shah of Principal Global Investors. Also, futures traders slightly trimmed the amount of further Fed easing expected this year, though they are are still leaning toward another quarter-point cut.

“The five members who believe rates should end the year higher than where they are currently are pushing up the short-end,” said Shah, Principal’s chief strategist. “His communication suggests quite convincingly that the economy is stabilizing, yet they stand ready to take further action if necessary.”

Rates on 2-year yields rose 2.3 basis points after the decision, to 1.75%, while 10-year yields were 1 basis point lower at 1.79%. The dollar gained, outperforming its major peers.

The yield curve is monitored because it has reliably predicted U.S. recessions within 18 months of short-term yields exceeding long-term ones. The spread on this section of the curve went below zero -- aka inverted -- last month for the first time since 2007.

Policy makers pledged to “act as appropriate” to sustain the U.S. expansion and continued to characterize the nation’s labor market as “strong.” Given that they don’t appear to be “pre-committing” to further cuts, the 2- to 10-year gap could easily revisit inverted territory, according to Subadra Rajappa, Societe Generale’s head of U.S. rates strategy.

“The dots suggested a divided committee, but it doesn’t take a lot of dots to shift down to move the median lower,” she said. “So they are sticking to the ‘data dependence’ mantra for now.”

--With assistance from Edward Bolingbroke.

To contact the reporter on this story: Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Nick Baker

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