Inside Markets — 2-Year Yields

Market-based probability for a March rate cut has declined to 44% into tomorrow’s Fed meeting from 65% last week. The OIS market remains priced for 100bp of rate cuts in ’24 to end the year at ~4.20%. Note that OIS markets were priced for only 25bp of cuts back in mid-October. Tomorrow’s updated median ’24 dot is expected to reflect a year-end rate of 4.875% with a hawkish press conference meant to offset the recent easing in financial conditions.  At the moment, the bond market is telling us that hawkish rhetoric should be ignored given the Fed’s dual mandate of price stability and maximum employment.  

The Fed tends to follow the collective intelligence of markets, not the other way around.  Historically, the Fed has generally followed the pricing in 2-year Treasury yields, which currently trade at 4.70% and approaching key technical resistance in the 4.80%-4.84% range. An inability to trade above that range now would be a bullish signal for bonds (yields lower) in Q1’24.

At current levels, two-year yields imply the 2/10 curve will be 100bp steeper by this time next year. That would take the 2/10 curve from 50bp inverted to 50bp steep, which would greatly improve bank profitability assuming no major consumer credit issues emerge.

Last week the Fed’s updated Z.1 report showed consumer cash levels in checking, savings and money market funds remain ~33% above year-end 2019 levels. The decline from peak cash levels seen in Q2’22 implies a burn rate of ~$25B/month. Americans tend to consume until they lose their job, which is also when credit issues begin to emerge. Note that last week’s Jobs Report with a higher participation rate reflects ongoing tight labor market conditions.