(Recasts, updates yields)
By Kate Duguid
NEW YORK, March 21 (Reuters) - The spread between the three-month Treasury bill yield and the 10-year note yield shrank to its narrowest level since August 2007 on Thursday in the wake of the Federal Reserve’s decision to cease tightening monetary policy as the American economy shows signs of contraction.
A narrower spread between the three-month and 10-year yields indicates increased market expectations of a recession. The three-month and 10-year spread is the Fed’s preferred measure of the Treasury yield curve as it shows the strongest historical correlation between curve inversion and forthcoming recession.
The last time the three-month to 10-year yield curve inverted - when the spread fell below zero basis points - was in August 2007, shortly before the low in spreads trumped on Thursday.
U.S. Treasury note yields across maturities were slightly higher on Thursday, reversing some of the rally in prices that began on Wednesday after the Fed issued a statement showing policymakers foresaw no further rate hikes for 2019 given the slowdown in the American economy.
In a major shift, the U.S. central bank also expects to raise borrowing costs only once more through 2021, and no longer anticipates the need to guard against inflation with restrictive monetary policy. It also said it would halt the steady decline of its balance sheet in September.
The benchmark 10-year yield, which reflects investor views on the overall health of the economy, fell to a 14-month low on Wednesday but was last up 0.3 basis point to 2.541 percent. The two-year yield, which reflects investor expectations about interest rate hikes on Wednesday fell 6.9 basis points but was last up 1.2 basis points at 2.413 percent.
“The Fed has doubled down on its dovish tilt,” said Matt Freund, head of fixed-income strategies at Calamos Investments. “The global economy is clearly softening and the Fed is looking at liquidity conditions.”
“Back in Q4 they weren’t even talking about developments outside the U.S. and that came up two or three times in the first 10 minutes of (Fed Chair Jerome Powell’s) commentary.”
In January, the Fed pivoted after hiking rates four times in 2018, pledging patience before making further moves. Rates are now seen peaking at 2.6 percent, sometime in 2020, roughly a percentage point lower than the historic average for the fed funds rate and a sign that the U.S. economy has entered a more sluggish era. (Reporting by Kate Duguid; Editing by David Gregorio and Chizu Nomiyama)