By Davide Barbuscia

NEW YORK, (Reuters) – While many Americans are focused on the Federal Reserve’s aggressiveness in tightening its policy, strategists and investors from the United States start to fear what might seem like a far-off threat.

In recent days, investors have become increasingly concerned about the prospect of an even more hawkish Fed. Some fear that an aggressive interest-rate-hiking and reversed U.S. central banks’ bond-buying programs could result in a sharp slowdown.

The Fed’s hawkish policy, as it concludes its two-day policy meeting, on Wednesday, has driven up short-term rates and flattened the closely watched yield curve for U.S. Treasuries.

Matthew Nest (global head of fixed income active), stated, “I am intently focused upon the yield curve.” State Street (NYSE:) Global Advisors. Slowing down demand is the only way that the Fed can reduce inflation, and it runs risk of causing recessions or sharp declines in growth. This dynamic causes the yield curve’s slope to become flatter and increases risk market strain.

On Tuesday, the yield curve for 2-year and 10-year notes slid to less than 75 basis point. This is the lowest gap since Dec. 28, 2008.

As stocks fell, the U.S. benchmark 10-year yields were retrenched. This was partially seen as a flight from safety. But it showed how delicate the Fed is in its plans to remove pandemic stimulus liquidity (from the markets) to curb rising inflation.

Michael de Pass from Citadel Securities, the global head of U.S. Government Bond Trading, stated that markets are pricing in concern over a temporary, relative short-term inflationary issue that could lead to Fed actions that will ultimately be damaging to economy.

David Kelly is the chief global strategist at J.P. Morgan Asset Management. He stated last week that Fed tightening may lead to a correction of financial markets. But he also said that it could cause a U.S. depression.

The economy is gaining momentum so the fears might seem far away. Economists surveyed by Reuters believe that 2021 will see growth of 5.6%. This would mark the fastest rate since 1984. 2.4% of the country’s economy was lost in 2020.

Gary Black is the Future Fund Active ETF manager. He said that people used to worry about growth only four to six months ago, but now they “really worry that there’s too much growth.” This was referring to the decline in the Small-Cap Index, which dropped more than 20% from the record close on Nov. 8 before being able to reverse its downward trend and move higher.

Black said, “That’s what the schizophrenic market is all about.”

Tobias Adrian, director of the International Monetary Fund’s Monetary and Capital Markets Department, said while there was some talk in the market about recession due to the yield curve’s flattening, it was not expected.

Adrian stated that “We expect growth to continue, although it will slow in the coming years, but we are optimistic about its future.” Tuesday’s economic forecasts by the IMF for China, America and the world economy were lowered by the IMF.

NORMALIZATION?

BlackRock’s chief executive Larry Fink warned that there could be a curve inversion if the Fed accelerates monetary policy adjustments to reduce inflation.

Historically, the yield curve’s last negative turn was in 2019, which has historically been a signal that there will be a recession within one to two years. This recession was caused by the coronavirus in the United States and lasted for only two months. It ended with a low point at April 2020.

Some investors believe the U.S. Treasuries rally over the last few days is a normalization of yields after they spiked too rapidly since the beginning. Economic data don’t point to a possible recession.

Subadra Rajappa (OTC) is the head of U.S. Interest Rate Strategy at Societe Generale.

Guneet Dahingra is the head of U.S. Interest Rate Strategy at Morgan Stanley (NYSE:) The flattening of the curve has been made worse by the demand for pension funds at the back.

“I do not worry about the recession fear, as evidenced by the curve flattening. He said that he believes it is more technical than fundamentals.