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

The flight to quality that occurred as the banking system teetered drove US Treasury yields down dramatically. However, in the process, did it create a situation in which Treasuries were overbought? Given that the US Federal Reserve has indicated that US interest rates would continue to rise and that an easing in monetary policy was unlikely in 2023, where do you think that US rates, particularly on the short end, will be going?

As the graph above highlights, the US 2-year Treasury Note yield has historically moved in lockstep with the US Fed Funds Rate. That is, until recently. Today, the upper FFR bound is 5%, while the yield on the 2-year Treasury Note has fallen to 4.0% (1:46 pm). This recent shift in rates has created an incredible gap that rarely exists, especially since 1990. Are market participants right in assuming that economic conditions have deteriorated and warrant this move down in rates, or are they once again blind to the Fed’s objective of raising rates to combat inflation as they seek price stability?

My money has been on the Fed since they first elevated the FFR on St. Paddy’s day in 2022 (+25 bps). The peak in the 2-year Treasury Note’s yield touched 5.07% just prior to SVB’s collapse and the subsequent rally in Treasuries. The Note’s yield bottomed last week at 3.78% before beginning its recent climb to today’s 4.0%. What’s the next move? Will the US 2-year note’s yield once again be a proxy for the FFR or will the Fed realize the “error of their way” and surprise the market with easing that drives the FFR down? I think that you know where I stand.