Karen Brettell and Davide Baruscia

(Reuters) – Investors examine whether a relatively quick Federal Reserve balance reduction could boost the Treasury yield curve. This has been flashing signs of a possible recession.

Minutes from the central bank’s March meeting showed Wednesday that the Fed intends to begin reducing its $9 trillion balance sheet in coming months, eventually reducing its holdings of Treasuries and mortgage backed securities by $95 billion per month – a faster clip than when it undertook quantitative tightening from 2017 to 2019.

The pace of the Fed’s runoff could help boost yields of longer dated Treasuries back above shorter dated ones, depending on how the Treasury restructures its debt issuance to make up for the Fed’s declining purchases.

This may be a relief to some market participants who were concerned about the recent inversions in various areas of the yield curve, such as the gap between the two-year yield and the 10-year yield.

Although such inversions have been known to signal past recessions, analysts differ on the validity of the signals. Some say that Fed’s extraordinary bond purchases may cause longer-dated yields to be lower than normal.

The possibility of an inversion in negative territory may reduce the fear about recession. However, it might also strengthen the suspicion that Fed bond holdings were responsible for the inversion.

“This should steepen the curve. They obviously are well aware that a flat curve is very concerning to us as market participants,” said John Luke Tyner, fixed income analyst at Aptus Capital Advisors.

On Wednesday, the 10-year and two-year yield curves climbed to 13 basis points after inverting by minus 10 base points Monday. Benchmark 10-year yields were 2.659%. This is the highest level since March 2019. Benchmark 10-year yields reached 2.659%, which is the highest level since March 2019.

Market consensus would dictate a steeper yield curve. According to Reuters, 60 fixed income strategists polled by the company showed that no significant rise in 10-year note prices was expected soon. This leaves the yield curve flattening or at constant risk of inversion in the next year.

A Fed decision to place more emphasis on balance sheet shrinkage to tighten financial circumstances could lead to the yield curve steepening. That could mean they are less inclined to hike rates. [[L1N2UB1UH]]

GennadiyGoldberg, an interest rates strategist at TD Securities, New York, stated that the big question is “how much balance sheet reduction is worth compared with rate hikes.” If the Fed relies more on balance sheet reductions “that might help steepen the curve a little bit, because it’s been the front-end of the curve that’s been furiously selling off and that could start to stabilize.”

Wall Street is speculative about Fed policy, and there are few indications that inflation will slow down.

Deutsche Bank (DE:), Tuesday’s first large bank forecasted a recession. It said that the combination of geopolitical instability and inflation resulting from the conflict in Ukraine, and heavy Fed tightening would lead to a decline in the U.S. economic growth by next year and an immediate 20% fall in stock prices.

The bank’s analysts expect the Fed to raise rates by 50 basis points at its next three meetings “with balance sheet rundown adding at least another 75bp-equivalent in rate hikes,” according to a recent report.

Wednesday’s minutes appeared to jibe with those expectations, setting the stage for meatier interest rate hikes down the line and reinforcing the view that the Fed is squaring off against sky-high rising consumer prices. The first rise in interest rates since 2018 was achieved by policymakers last month with a 25-basis point increase.

“A lot of this is an affirmation of the (Fed’s) hawkishness,” said Christopher Alwine, head of the Global Credit Team in Vanguard Fixed Income Group. “They’re trying to slow down the economy, and typically, the pattern of the Fed has been they do that until something breaks, and something usually breaks in the financial markets first.”

Analysts Morgan Stanley According to (NYSE):, the Fed has exceeded its forecasted $80 billion per monthly projections in a new note.

The minutes overall showed that policymakers were more concerned about inflation upside risks than they were discussing growth risks and the risks of the future.