A Clue From the Two

From the Desk of Ian Culley @Ianculley

After Federal Reserve Chair Jerome Powell’s remarks this morning, the market is pricing in an 86% chance of a 75-basis-point hike later this month. 

Meanwhile, rates continue to accelerate at the short end of the curve. That’s been the story for months now. 

But will the middle and long end of the curve head higher as well?

According to the two-year US Treasury yield, the answer is a resounding "yes!"

Short-duration rates offer plenty of valuable, leading information regarding US Treasury yields.

We’ve leaned on the five-year yield throughout the current cycle as an early indication of the direction of the 10- and 30-year. It’s proved a beneficial practice.

Today, we’re going to drop it down a notch, extending the same logic to the two-year yield.

Here’s a quad-pane chart of the two-, five-, 10-, and 30-year US Treasury yields:

Starting in the upper-left corner, the two-year is well above its former 2018 highs and hitting levels not seen since November 2007.

The rest of the pack has also reclaimed their prior cycle highs marked by the 2018 peaks. But year-to-date highs remain a hurdle.

If the two-year is any indication, those former highs only represent a temporary obstacle.

But there’s more evidence overseas hinting that rates are on the rise across the curve.

Developed European benchmark rates are holding above prior-cycle highs. And those long bond trades we put on earlier in the year were short-lived. We had to flip the book short after the 2018 lows were violated last week.

That says a lot.

If the bond market is flashing "sell" signals, we’re making the bet that rates will continue to climb.

As long as this is the case, we want to position ourselves in areas of the market that reap the most reward from rising rates, such as materials, energy, and financials.

Stay tuned as we continue to monitor the short end of the curve for additional clues.

Countdown to FOMC

Following Powell's most recent comments, the market is pricing in a 75-basis-point hike later this month.

Here are the target rate probabilities based on fed funds futures:  

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of September 8, 2022.

Thanks for reading. And please let us know what you think.

As always, be sure to download this week’s Bond Report!