TREASURIES-Yield curve flattens as Fed seen more proactive on inflation

       By Karen Brettell
    NEW YORK, June 18 (Reuters) - Long-dated U.S. Treasury
yields fell on Friday and the yield curve continued to flatten,
albeit at a slower pace, as market participants bet that the
Federal Reserve will act sooner to clamp down on inflation
pressures if they persist.
    The Fed surprised markets on Wednesday when it said that
policymakers are forecasting two interest rate hikes in 2023.
    The statement sent two-year and five-year yields, which are
the most sensitive to rate changes, higher. Long-dated yields,
however, have since dropped, led by declines in 30-year bond
yields.
    Analysts say that many investors are unwinding trades that
were betting on higher inflation as the U.S. central bank
indicates it will not let price pressures surge as high as some
were fearing.
    "It does seem as though the market has now shifted its view
that the Fed's going to let inflation run wild, to the Fed's
basically going to kill inflation in the cradle," said Gennadiy
Goldberg, an interest rate strategist at TD Securities in New
York, adding that "the truth is probably somewhere in the
middle."
    "They are trying to reinforce their control of the
narrative. I don't think they want the narrative to be that the
Fed is behind the curve on inflation," Goldberg said.
    Yields jumped on Friday after St. Louis Federal Reserve bank
President James Bullard said he thinks rate increases will begin
next year as inflation rises faster than expected.
    "We were expecting a good year, a good reopening, but this
is a bigger year than we were expecting, more inflation than we
were expecting, and I think it's natural that we've tilted a
little bit more hawkish here to contain inflationary pressures,"
Bullard said.
    Two-year yields jumped to 0.254%, the highest
since April 2020. Five-year yields increased to
0.928%, the highest since April 6.
    The yield curve continued to flatten after Bullard's
comments.
    The curve between five-year and 30-year bonds
has seen the largest move, flattening to 115 basis points on
Thursday, the smallest yield gap since November. It has
flattened from 140 basis points before the Fed statement.
    Analysts say the move is being exaggerated by investors
unwinding crowded trades betting on curve steepening.
    "We think it's possible long-end steepeners were being used
as a positive carry way of positioning for higher yields,
especially with the expected Fed liftoff date nearly two years
away, and the unwinds of those positions added flattening
pressure," analysts at JPMorgan said in a report on Thursday.
    The yield curve between two-year and 10-year notes
 flattened to 125 basis points on Friday, the
flattest since February.
    Benchmark 10-year notes were last at 1.506%.
    JPMorgan analysts are maintaining a short recommendation on
10-year notes, adding that they think the first rate hike will
not be until the second half of 2023 and that they "expect
policy will remain accommodative for some time following
liftoff."
    The fed funds futures market is pricing for rate
hikes to begin in February 2023.
    The cost of borrowing Treasuries in the overnight repurchase
agreement market (repo) was at 6 basis points on
Friday. It has risen since the Fed on Wednesday raised the
interest rate it pays banks on reserves by five basis points to
0.15%, and the rate it pays on overnight reverse repurchase
agreements to 0.05% from zero.
    The fed funds effective rate rose four basis
points on Thursday to 10 basis points, the highest since August
2020.
  June 18 Friday 9:40AM New York / 1340 GMT
                               Price        Current   Net
                                            Yield %   Change
                                                      (bps)
 Three-month bills             0.0425       0.0431    0.005
 Six-month bills               0.055        0.0558    0.005
 Two-year note                 99-193/256   0.2521    0.039
 Three-year note               99-74/256    0.4903    0.058
 Five-year note                99-42/256    0.9234    0.044
 Seven-year note               99-214/256   1.2747    0.020
 10-year note                  101-24/256   1.5056    -0.005
 20-year bond                  103-188/256  2.0211    -0.024
 30-year bond                  106-192/256  2.071     -0.030

   DOLLAR SWAP SPREADS
                               Last (bps)   Net
                                            Change
                                            (bps)
 U.S. 2-year dollar swap         6.25        -1.25
 spread
 U.S. 3-year dollar swap         7.00        -2.00
 spread
 U.S. 5-year dollar swap         5.50        -0.75
 spread
 U.S. 10-year dollar swap       -4.25        -0.75
 spread
 U.S. 30-year dollar swap      -30.25        -0.75
 spread


 (Reporting by Karen Brettell; editing by Jonathan Oatis)

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