Yields rebound, curve inverts again after brief positive shift

By Karen Brettell

NEW YORK (Reuters) -U.S. Treasury yields rebounded from one-year lows on Monday on greater optimism over the U.S. economy and a closely watched part of the yield curve reinverted, after briefly turning positive for the first time in two years.

Yields tumbled earlier on Monday on recession fears, following an unexpected increase in the unemployment rate and fewer than expected job gains in July’s employment report on Friday.

That caused a rapid repricing of expectations on when and how far the Federal Reserve will cut interest rates.

But yields rose off their lows after Chicago Fed President Austan Goolsbee said on Monday that the jobs data does not indicate a recession, while noting that Fed policymakers must carefully monitor changes in the U.S. economy to avoid being too restrictive with interest rates.

Goolsbee is "notably the most dovish member for quite some time at the Fed and he didn't suggest that there was any real alarm," said James Knightley, chief international economist, US at ING.

U.S. services sector activity also rebounded from a four-year low in July amid a bounce back in new orders and the first increase in employment in six months.

"The ISM services report was pretty good," said Knightley. "We're starting to see a little bit of calm return and a little bit of stability return" to the market.

Traders are now pricing in an 86% chance the Fed will cut rates by 50 basis points at its next scheduled policy meeting in September, and a 14% chance of a 25 basis point reduction. A 50 basis point cut was fully priced in earlier on Monday, with a 75 basis point cut also seen possible, according to the CME Group's FedWatch Tool.

Traders had also begun positioning for a possible emergency rate cut before September.

Yields on interest rate sensitive two-year notes were last up 1 basis point at 3.883%, after earlier getting as low as 3.654%, the lowest since April 2023.

Benchmark 10-year note yields fell 2 basis points to 3.777%, after reaching 3.667%, the lowest since June 2023.

The gap between two- and 10-year Treasury notes was last at minus 11 basis points, after earlier reaching 1.50 basis points. It is the first time it has turned positive since July 2022.

An inversion in this part of the yield curve typically indicates that a recession is likely in the next one-to-two years, though this inversion has lasted longer than in previous episodes.

The curve usually turns positive before a downturn begins.

TUMBLING STOCKS, GEOPOLITICAL CONCERNS ADD BID FOR BONDS

Tumbling stock markets and concerns about increasing geopolitical tensions in the Middle East have added to demand for safe haven U.S. government debt in recent days.

U.S. stocks have also been hurt by some recent weak earnings outlooks and stretched valuations.

"The move over the last two days in particular, that's not as much driven by fundamentals as it is by the correction in U.S. equity markets," said Michael Weidner, co-head of global fixed income at Lazard Asset Management.

Traders unwinding popular trades in which they sold the Japanese yen and bought U.S. assets has also increased fears of large portfolio liquidations across asset classes.

Upcoming inflation releases and the jobs report for August will be key to whether the Fed makes a larger cut in September, assuming it doesn't act before then.

"It depends on the August payroll number, if it’s similarly weak (to July) then there’s a good case for a bigger cut,” said Jim Caron, CIO, cross-asset solutions at Morgan Stanley Investment Management.

Yields may also be pulled higher by new Treasury supply this week. The Treasury Department will sell $125 billion in coupon-bearing debt, including $58 billion in three-year notes on Tuesday, $42 billion in 10-year notes on Wednesday and $25 billion in 30-year bonds on Thursday.

(Reporting By Karen Brettell; Additional reporting by Harry Robertson, Ankur Banerjee and Lisa Pauline Mattackal; Editing by Nick Zieminski, Sharon Singleton, William Maclean)