(Bloomberg) -- The Treasury yield curve flattened the most in 11 weeks on concern US President Donald Trump’s move to unleash tariffs on top trading partners may push the economy into stagflation.
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Yields on benchmark two-year Treasuries rose five basis points to 4.25%, while those on the 10-year fell one basis point to 4.53%. The gap between the two shrank the most since Nov. 14 on an intraday basis.
Trump made good on his threat to impose levies on the exports of Canada, Mexico and China, fueling the risk of a tit-for-tat trade war. With higher tariffs threatening to boost inflation and hurt growth, the world’s largest economy risks falling into stagflation, according to DBS Bank Ltd. and SMBC Nikko Securities Inc.
“A widening of the tariff war would raise the specter of stagflation,” leading to a flatter Treasury yield curve in the process, said Eugene Leow, a senior rates strategist at DBS in Singapore. “If risk-off worsens, there should be downward pressure on 10-year yields.”
The rise in short-dated yields reflects speculation that a higher cost of living would prevent the Federal Reserve from lowering interest rates. The drop in 10-year yields signals investor concern over US growth prospects, with traders also preparing for the first Treasury refunding announcement under the Trump administration on Wednesday.
The Fed last week left interest rates unchanged as it waited to see progress on inflation following a string of rate reductions last year. Trump said on Sunday evening that “holding the rates at this point was the right thing to do.” He also said tariffs on the European Union “will definitely happen.”
Overnight-indexed swaps reflected about a 70% chance of two rate cuts this year, down from 90% on Friday. Data on Friday showed that the Fed’s preferred measure of underlying inflation remained muted in December and that real disposable income barely rose.
A further increase in the cost of living is expected to result in an economic slowdown, Makoto Noji, chief foreign-exchange and foreign bond strategist at SMBC Nikko, wrote in a note. “As the risk of stagflation rises, it’s highly likely that US long-term yields will come under downward pressure.”
(Adds Treasury refunding announcement in fifth paragraph. An earlier version of this story corrected time reference in penultimate paragraph.)