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TREASURIES-Omicron and inflation flatten U.S. yield curve

·2 min read

SYDNEY, Dec 2 (Reuters) - Long-term yields neared their lowest for the year on Thursday as investors wagered that early rate hikes would curb future inflation, leading to a sharp flattening of the entire curve.

Thirty-year Treasury yields hit 1.74% in late New York trade, their lowest since January. They were last at 1.7778%. Two-year yields rose 3 basis points (bps) on Thursday to 0.5829%, not too far from their highest level since the pandemic of 0.6320%.

Assuming that higher rates next year will ultimately translate to lower inflation and a lower peak in interest rates later on, traders have squeezed the gap between two-year and 10-year yields to the narrowest in eleven months.

Worries about the Omicron variant have also lent a safety bid to bonds. Since news of the variant broke, just after Thanksgiving, benchmark 10-year yields have dived more than 25 bps in a painful rally for a market heavily short.

"Markets remain in disarray as investors price in higher odds of a faster Fed taper and an earlier rate hike amid thin liquidity," said strategists at TD Securities.

The first case of the Omicron variant was reported in the United States on Wednesday, adding to the unease.

Federal Reserve Chair Jerome Powell also this week flagged a chance of faster moves to head off inflation.

Ten-year yields last stood at 1.4341%, up 3 bps in Asia. Five-year yields rose 3.7 bps to 1.1693%. The gap between five-year and 30-year yields, at just under 60 bps, is near its tightest since March 2020.

The stubbornly firm long end, which is a benchmark for mortgage rates and other elements of financial conditions, could even heap extra pressure on the Fed to do more at the short end.

"Something has to give," said Deutsche Bank stragegist Alan Ruskin. "Either long-term rates move higher, or, the terminal rate has to move higher, or both," he wrote in a research note.

"The alternative view is that the recovery is so mature or fragile the momentum fades without any policy push, or the massive helicopter liquidity drop fades and so does nominal GDP...but even then, surely more than 150 bps of tightening are needed to slow 11% nominal GDP growth down to a more sustainable 4%." (Reporting by Tom Westbrook; Editing by Devika Syamnath)