August 21, 2019

Bond Investors Seem Sure the Fed Will Cut Rates, but Not About When

Bond Investors Seem Sure the Fed Will Cut Rates, but Not About When


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The Federal Reserve is deliberating over its plans for interest rates in the year ahead. Bond investors appear to have already made up their minds about what will happen.

Yields on almost every security offered by the Treasury Department — including debt that’s due in one month or 10 years — have fallen below the Fed’s target range for its benchmark interest rate, known as the federal funds rate.

That means investors expect the Fed to push interest rates lower and keep them there. Only the longest-maturity security the United States government sells, the 30-year bond, is trading above the Fed’s target rate range of 2.25 percent to 2.5 percent. But it is not far off. By late Tuesday, the 30-year bond was yielding 2.55 percent.

The shift lower accelerated in May with the escalation of trade tension between the United States and China, and it is another indication that investors believe the Fed made a mistake when it raised interest rates four times last year.

That the yields on almost all the securities sold by the government have fallen below the Fed’s target rate also serves as another warning signal about the economy. Only twice in the past 20 years have the yields on every Treasury dropped below the federal funds rate for a period. In both instances, the move lower preceded an economic downturn — first with the bursting of the dot-com bubble in 2001, and later as the 2008 financial crisis approached.

[Read more about what the bond market is saying about the economy.]

Interest rates on government bonds have broadly moved lower this year. The yield on the two-year and five-year bonds dropped below the Fed’s short-term benchmark at the end of January. Nearly two months later, the 10-year bond slid below Fed’s target rate of 2.5 percent.

But the declines in the rates on each bond offered by the Treasury were not equal. The yield on the shortest-term bills (like the three-month bill) fell the least, while the steepest decline came in the two-year note. Last month, it plunged nearly a half a percentage point to 1.86 percent, which kept its yield below that of the 10-year note.

That suggests investors are anticipating that the central bank will lower rates once in the next month and will become more aggressive in cutting rates after that.

How good are bond investors be at predicting the Fed’s next move? The answer could become a bit clearer when the central bank finishes its June policy meeting Wednesday.



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