By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Early last week, shortly after Fed Chairman Powell delivered his testimony to Congress, US Treasury yields moved skyward. There seemed to finally be a realization that US inflation, while down from its peak, was still stubbornly high and sticky. As a result, interest rates moved as one would expect, with the 2-year Treasury Note reaching a yield of 5.31%. Thus reaching its highest level since November 2000. What has transpired since last Wednesday (3/8) is nearly unparalleled.
The Bloomberg chart above reflects a massive shift in sentiment that is directly related to what transpired with Silicon Valley Bank and Signature Bank, and heightened fear that other regional banks would crumble as a result of the Fed’s massive interest rate push and the impact that effort has on a bank’s investments. As a result, Treasury yields have plummeted, with the 2-year yield being repriced by 118 basis points in 5 trading days. Monday’s 61 basis points decline was the most significant move since 1982 when the US interest rate environment was recovering from double-digit highs.
Does this significant repricing of US Treasury rates make the US Federal Reserve’s effort to control inflation more challenging? We, at Ryan ALM, Inc., believe that it does. The Fed’s objective in raising the Fed Fund’s Rate is to thwart economic activity by reducing demand for goods and services. Recent economic activity suggests that demand for goods has waned considerably as supply imbalances have been eradicated. However, service-related inflation remains sticky and elevated. Financial conditions certainly seem to have gotten easier with these lower rates. February’s housing activity suggests that economic activity isn’t collapsing, and these lower Treasury yields may inspire potential buyers of existing and new homes to get off the sidelines.
Most market participants believe that the Fed will focus its attention on the current banking crisis and as such, reduce the next FFR increase from 50 bps to 25 bps, with a large percentage now believing that the Fed will pause increasing rates. If so, inflation is not likely to continue its recent path lower, as we still have a robust labor market with decent wage growth and heightened demand for services. When was the last time that you were on a plane and had an open middle seat in your row?