(Bloomberg) -- Treasuries extended their surge Friday as new data on US manufacturing added fuel to concern that Federal Reserve rate hikes will lead to a recession.
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Benchmark yields slumped across the curve, with those in the belly and the short-end leading the way and the five-year rate at one stage plummeting by more than a quarter of a percentage point to 2.78%. The widely watched 5-to-30-year yield curve differential steepened by more than 10 basis points on the day.
The Institute for Supply Management's manufacturing gauge fell more than expected in May to 53, while new orders and employment dropped below a reading of 50, entering contraction territory.
The final US data release before the Independence Day long weekend, fanned mounting recession concerns that has driven traders to price in rate cuts next year after the Fed's tightening peaks next March.
The latest leg of the global bond-market rally came after Fed Chair Jerome Powell said Wednesday that the risk of harm to the economy from higher rates was less important than restoring price stability.
Traders continue to expect another 75-basis-point rate increase as the most likely outcome for the Fed's next scheduled meeting in July, but the odds have lessened and bets on a peak have been pulled back to March 2023. The fed funds benchmark is now seen maxing out below 3.40% in the first quarter of 2023, based on swaps pricing.
The prospects for a US recession were enhanced Thursday after figures showed personal spending for May rose 0.2%, half the expected increase. The price index for purchases rose 0.6% versus an expected 0.7%, supporting the view that an inflation peak is being established.
Market-implied inflation expectations have been falling steadily along with nominal yields over the past three weeks. Among them, the five-year forward estimate of the five-year expected inflation rate briefly neared 2% earlier on Friday, where it last traded in February before spiking to 2.6% in April. The Fed targets a 2% average inflation rate over time.
The shift in the US bond market to pricing in recession risk is being emulated globally. In Australia, the three-year yield tumbled as much as 21 basis points, just days before its central bank is expected to announce a half-point rate increase, while European yields also dived.
Germany's two-year bond is on track for its biggest weekly trading range since 2008 as the market rapidly pares bets on rate increase by the European Central Bank. The yield on the security -- the most sensitive to changes in policy expectations -- has more than halved from a high of 1% Tuesday to trade as low as 0.48% Friday. Traders are bracing for around 140 basis points of hikes this year, compared with as many as 190 basis points on June 16, with the repricing being spurred by speculation inflation in the region is showing early signs of cooling.
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