Powell reiterated higher for longer at the last FOMC
but yields have stopped rising
A thread on interest rate divergence
but yields have stopped rising
A thread on interest rate divergence
2/ The Fed hiked 50 bps in December 2022 putting the Fed Funds rate at 4.25% - 4.5% range
This puts the Fed Funds rate above the 10-year Treasury yield for the first time in this tightening cycle
This puts the Fed Funds rate above the 10-year Treasury yield for the first time in this tightening cycle
3/ Everytime the Fed Funds has moved above the 10-year yield, the Fed historically pivoted by either pausing or cutting rates
4/ This is because the unemployment rate moved higher following such as occurrence, signaling significant economic weakness
And eventually led to a recession
And eventually led to a recession
5/
β> The bond market is calling BS on the Fedβs monetary policy plans as the 10-year Treasury yield sits above the Fed Funds rate
The 2-year Treasury yield is also signaling the same message
β> The bond market is calling BS on the Fedβs monetary policy plans as the 10-year Treasury yield sits above the Fed Funds rate
The 2-year Treasury yield is also signaling the same message
6/ 2-year Treasury yield has been moving lower despite a hawkish tone from the Fed
7/ The Federal Reserve historically follows the 2-year Treasury yield
And the Fed Funds rate rarely deviates too much from the 2-year yield
And the Fed Funds rate rarely deviates too much from the 2-year yield
8/ 2-year Treasury yield is the market expectation of monetary policy over the next 2 years
And very rarely does the Fed Funds rate stays higher than the 2-year yield
And very rarely does the Fed Funds rate stays higher than the 2-year yield
9/ When it does happen, it leads to a pause or outright pivot in monetary policy
10/ Currently the 2-year yield is sitting around 4.35%
Meaning the 2-year yield is not expecting the Fed Funds rate to rise much more than it already has
Meaning the 2-year yield is not expecting the Fed Funds rate to rise much more than it already has
11/ Throughout 2022, the 2-year yield has systematically stayed above the Fed Funds rate
β> the market was expecting monetary policy to continue tightening in the near term
β> the market was expecting monetary policy to continue tightening in the near term
12/ More recently this spread has been dropping like a stone
And is currently close to 0 with a value of 0.14%
And is currently close to 0 with a value of 0.14%
13/ This chart marks the previous 8 instances when the spread between the 2-year Treasury yield and Fed Funds rate has gone from an elevated level to 0
14/ The Fed Funds rate shows the positioning of monetary policy at each of the vertical lines
15/ In all of these instances, the Fed pivoted its monetary policy
And this even worked during easing cycles like in 2002 and 2003
And this even worked during easing cycles like in 2002 and 2003
16/ As soon as the Fed pivot occurred, the stock market rallied in 7 of the 8 instances
With the only exception in 2000
With the only exception in 2000
17/ Weβre currently nearing a similar setup as the Fed Funds rate moves above the 10-year and 2-year Treasury yield
And itβs bullish for the stock market if earnings hold up in the next couple of months
And itβs bullish for the stock market if earnings hold up in the next couple of months
18/ Thanks for reading!
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