From the desk of Willie Delwiche.
Key Takeaways:
- Flat-footed Fed hurrying to get policy in harmony with reality
- German yields paving the way for US yields to exceed expectations
- Higher yields adding volatility, but Fed to focus on evidence of stress
Developments in and around the Ukraine are dominating the headlines, but history shows that market turmoil brought on by geopolitical events tends to be short-lived. More meaningful and lasting developments are coming from the bond market as it adjusts to a Federal Reserve that appears intent to aggressively bring policy more in line with inflation. The Fed needs to catch up to inflation (and economic fundamentals generally) and the bond market needs to catch up to the Fed.
The 10-year yield reflects what the market thinks the economy can handle, the 2-year yield reflects what it thinks the Fed will do and the 3-month yield reflects what the Fed has done. It’s not uncommon for longer yields to move first and be followed by shorter-term yields. The dramatic narrowing of the spread between 10-year and 2-year T-Note yields in recent months reflects a Fed that has changed course and is focusing intently on inflation. That is the game of catch-up that is being played. I would be more concerned with 10-year yields dropping below 3-month yields than with 2-year yields rising toward 10-year yields.
