U.S. Markets close in 4 hrs 30 mins

Dollar weak as U.S. Treasury yield curve inversion sparks recession fears

By Saqib Iqbal Ahmed
U.S. dollar notes are seen in this November 7, 2016 picture illustration. REUTERS/Dado Ruvic/Illustration

By Saqib Iqbal Ahmed

NEW YORK (Reuters) - The dollar edged lower on Tuesday as U.S. Treasury yields fell, feeding fears that the Federal Reserve could pause in its rate-hike cycle, while an inversion in part of the yield curve was taken as a red flag for a potential recession.

Lingering uncertainty regarding China and the United States' ability to resolve their trade war provided some support to the greenback. Still, investors were nervous about an inversion of the curve between three-year and five-year U.S. Treasury notes and between two-year and five-year notes.

These were the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt.

Analysts expected the two-year, 10-year yield curve to follow suit. This is seen as a portent of a U.S. recession.

Interest rate hikes have sent short-dated yields higher, even as slowing economic growth expectations have kept longer-dated yields down.

(Graphic: Part of the U.S. Treasury curve has already inverted - https://tmsnrt.rs/2Qe7Fxu)

"I think that's one of the main narratives triggering risk aversion," said Alfonso Esparza, senior currency analyst at OANDA in Toronto.

The dollar was 0.77 percent lower against the Japanese yen, which tends to benefit during geopolitical or financial stress as Japan is the world’s biggest creditor nation. The euro was 0.11 percent lower.

The dollar stumbled last week after Federal Reserve Chairman Jerome Powell on Wednesday said U.S. rates were nearing neutral levels, which markets interpreted as signaling a slowdown in rate hikes.

The yield curve inversion and comments from Fed speakers are causing investors to rethink the potential of a recession or if rate hikes are nearing the top, said Minh Trang, senior FX trader at Silicon Valley Bank in Santa Clara, California.

"If that's the case, obviously the dollar has had a nice run, I think we may be seeing the top on the dollar," he said.

Against a basket of six major currencies the dollar <.DXY> was down 0.07 percent at 96.972.

Meanwhile, trade-related tensions kept weighing on global financial markets. U.S. President Donald Trump on Tuesday held out the possibility of an extension of the 90-day trade truce with China but warned he would revert to tariffs if the two sides could not resolve their differences.

The Australian dollar, viewed as a barometer of Chinese growth, gave up early gains to trade 0.26 percent lower.

Sterling briefly swooned to a 17-month low on Tuesday, before recovering ground to trade little-changed on the day, in a volatile session dominated by Brexit-related headlines.

(Reporting by Saqib Iqbal Ahmed; Editing by David Gregorio)