By Davide Barbuscia

NEW YORK (Reuters). Sharp movements in the U.S. Treasury Market are increasingly pointing toward a near recession. “Bond vigilantes” have begun to emerge from the woodwork and markets seem to doubt the U.S. Federal Reserve’s plans to engineer a “soft land” for the economy, as it raises interest rates to reduce inflation.

Jerome Powell, Fed Chair said Monday that the U.S. central banks must “expectiously” move to curb excessive inflation. It could also use larger-than-usual rate increases if it is necessary. The yield curve of the U.S Treasury continued to flatten while bond yields rose, which are inversely related to price movements.

BofA strategists stated that “the market appears to be questioning the soft-landing vision for the U.S. economic system, which the Fed presented at the March FOMC meeting”.

Strategists stated that the U.S. Treasury yields curve shows “recession risks” as well as the curve’s extreme flatness in the beginning of the Fed tightening cycles.

Since the beginning of the year the closely-followed part of yield curve between 10-year Treasuries and 2-year Treasuries narrowed by approximately 60 basis points. The longer-dated notes are now yielding less that 20 basis points than the two-year-dated debt.

An inversion of this section of the curve when longer notes yield less than shorter ones is considered to be a warning sign that there will soon be a recession.

Christopher Murphy (Co-Head, Derivatives Strategy, Susquehanna Financial Group) wrote, “The yield curve certainly looks ominous,” although he acknowledged that inversions do not necessarily guarantee recession.

Melissa Brown from Qontigo’s Global Head of Applied Research, stated that the yield curve reflects a shift of market opinions on whether the Fed can tighten monetary policy enough to decrease inflation but not cause a recession.

“Maybe the market is thinking they won’t be able to thread that needle… we’ll have to work hard to keep us from going into recession,” she stated.

Powell, however, said on Monday that there was no high probability of a recession over the next 12 months. Others are also skeptical.

Powell responded to a question Monday regarding concerns about what the yield curve was saying. He said that he focuses on the short-end of the curve which means the first 18 months of maturities.

Morgan Stanley In a Sunday research note, (NYSE:) stated that an inversion in the yield curve is possible for the second quarter of this year. However, an inversion doesn’t necessarily predict a recession.

It stated that “it does support our view of sharply decelerating earnings growing,”.

Tim Holland is chief investment advisor at Orion Advisor Solutions. He believes that a recession, in spite of the flat curve, is unlikely.

A portion of the curve that compares three month bills with 10-year bonds has sharpened, going from 145 basis point on Dec. 31st to 181.54 base points on Monday.

He stated that “if the past 30 year is any indication, the curves need to be flattened and inverted before we’re at risk of recession.”

Some market participants were surprised by Powell’s Monday speech at the National Association for Business Economics conference. They seemed more cautious than his comments after the Fed raised the federal funds rates 25 basis points last Wednesday.

On Monday, yields jumped with the benchmark 10-year note rising to 2.298% (from 2.153% Friday) – its highest level since May 2019. The yields on two-year Treasuries rose to 2.111%, from 1.942%, Friday.

Andrew Brenner from National Alliance Securities, Head of international fixed income, said, “What you saw today was Powell literally throwing the towel in, he stated he’s willing to do whatever it takes and it took market a bit back.”

Brenner said that the bond market behaves like bond vigilantes. This is when investors insist upon high yields to counter inflation.

Brenner stated that “Bond vigilantes” had emerged from the woodwork, and added that he noticed a lot of selling on the futures markets, especially in five-year options.