Federal Reserve Chairman Jerome Powell made “dovish” comments earlier this month, leaving hope for rate cuts.
Al Drago/Bloomberg
The two-year Treasury yield is about to break out, and the move is worth noting as it signals the Federal Reserve may not be near the end of its interest rate hikes.
The two-year Treasury yield has risen to as high as about 4.7% in the past few days, and is settling at just below that mark for the moment. But it has had quite a run upward, as it has come from around 4.1% at its low point for this year.
Now it is close to its recent multiyear high of about 4.73% hit in early November. That is a key level partly because that is where buyers stepped in to promptly send the bond’s price higher and its yield lower (bond prices and yields move inversely). If there are few buyers this time around, it could mean that yield could break out and rise from there.
Before November, the last time the yield reached that level was in 2007, just before the 2008-09 financial crisis decimated markets and the Fed had to lower rates to stabilize the economy.
The yield’s current rise is signaling that the Fed probably has more rate hiking to do, as the two-year yield is often a barometer for expectations about where the ultrashort term federal-funds rate will land.
Indeed, the fed-funds futures market is reflecting an 82% chance that the central bank will lift the fed-funds rate to a range between 4.75% and 5%. By June, it could be between 5.25% and 5.5%.
“Markets have acknowledged this with 2 year yields having returned close to their highs,” wrote Citi economist Andrew Hollenhorst.
More rate hikes makes sense. Their goal is to reduce inflation by cutting into economic demand. Recently, the consumer price index rose just over 6% year over year, and while that is down from the just over 9% peak in 2022, it is still well above the Fed’s target of 2%.
To be sure, Fed Chairman Jerome Powell did make “dovish” comments recently, which means he sounded less adamant about remaining aggressive in lifting rates.
That is because the Fed knows demand and inflation often drop with a delay to when rates rise because consumers and businesses take a little while to spend less. So Powell is allowing for the possibility that inflation keeps declining without more increases.
But inflation is running above the Fed’s target enough that the bond market is signaling the likelihood that the bank will have to be hawkish, not dovish.
That is why the stock market is having trouble rising past a certain point. The
S&P 500
is up about 14% from a low point hit in early October, as it hopes for a more dovish Fed. But it now must grapple with the possibility of more rate increases—and more damage to the economy and corporate earnings. The index just can’t seem to surpass the level just under 4200, where it has seen sellers come in to knock it down several times since August.
It is all about the Fed. Keep an eye on the two year yield.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
Credit: marketwatch.com