By: Russ Kamp, Managing Director, Ryan ALM, Inc.

It is understandable why the investment community still believes that the Fed will cut rates at some point during 2023. As I’ve mentioned many times that unless you are my age and in the business for 40+ years, you have always experienced the Fed stepping into the fray and providing support whenever markets became wobbly. That support was in the form of a reduction in the Fed Funds Rate (FFR). I would suggest that the Fed’s game plan is very different this time. Why? They have said so! Many times!

Yet, their proclamations seemed to have fallen on deaf ears. According to Neel Kashkari president and CEO of the Federal Reserve Bank of Minneapolis, the target rate for the FFR is 5.4%, and he said just this morning that they could go beyond that level depending on what continues to happen in the US labor market and with wage growth. 5.4% or more! Janet Yellen, US Treasury Secretary, stated yesterday that recessions don’t happen in environments with 500+K job growth, 3.4% unemployment, and 4.4% annual wage growth.

However, I read this morning in a Bloomberg email that the current inverted yield curve, which has been inverted for the last seven months beginning in July, would have to see 2-year yields snap down rapidly since the 10-year has never “uninverted” before by having its yield rise through the 2-year Treasury yield (6 previous observations). That might have been the case, but again, we’ve enjoyed four decades of an incredible tailwind provided by falling inflation and lower US interest rates. That scenario no longer exists. With the prospect of a 5.4% FFR, why would the US 2-year Treasury yields fall rapidly? Core inflation remains stubbornly high. Employment remains solid. Wage growth is providing workers with opportunities to demand goods and services. Where is the recession? It certainly doesn’t seem immediate. Given those conditions, where is the 2-year Treasury yield going other than possibly up? 

Please stop looking at the last four decades of Fed policy as a clear indication of what they intend to do today. I was always taught to NOT ignore the Fed. The Fed has certainly been very transparent about the fact that they don’t see the FFR being cut in 2023. The FFR is 4.5%-4.75% today. The 2-year Treasury Note has a yield of 4.45%. The 10-year yield is at 3.65% (10:30 am). If the Fed achieves its current target for the FFR of 5.4%, is it truly realistic to presume that the 2-year Treasury yield is going to fall dramatically from its current level and get below the 3.65% 10-year Treasury yield? I believe that it is much more likely that the entire yield curve ratchets higher. Despite the Fed’s actions to date, little has been accomplished to get inflation (price stability) back to its 2% target. The US employment picture is just too strong for that to happen at this time.

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