Yield Curve Flattens as Trump Tariffs Raise Stagflation Fears
The yield curve flattened on Tuesday, with the two-year Treasury yield rising five basis points and the 10-year yield falling one basis point. The gap between the two narrowed to its steepest decline since November 14.
The move comes as the market reacts to President Donald Trump's tariffs on Canada, Mexico, and China. Economists warn that these tariffs could lead to a trade war, which could result in higher inflation and slower growth—a phenomenon known as stagflation.
"A widening of the tariff war would raise the specter of stagflation," said Eugene Leow, senior rates strategist at DBS in Singapore. "That would lead to a flatter yield curve."
The rise in short-dated yields reflects speculation that the Federal Reserve may not be able to cut interest rates if the cost of living increases. The drop in 10-year yields indicates concern over U.S. growth prospects.
The Fed left interest rates unchanged last week but left open the possibility of future cuts if inflation remains low. Trump said on Sunday that he supports the Fed's decision to keep rates on hold.
Overnight-indexed swaps currently indicate a 70% chance of two rate cuts this year, down from 90% on Friday.
Data released on Friday showed that inflation remains muted and that real disposable income has barely increased. Economists believe that a further rise in the cost of living could lead to an economic slowdown.
"As the risk of stagflation rises, it's highly likely that U.S. long-term yields will come under downward pressure," said Makoto Noji, chief foreign-exchange and foreign bond strategist at SMBC Nikko.