One of the major themes of 2022 is the Federal Reserve raising interest rates to crush inflation. For example, the Fed raised rates another 75 basis points on Wednesday.
Will that be enough? What will happen to interest rates?
This brings us to today’s chart where we compare fed funds to the yield on 2-year treasury bonds (a good short-term indicator of interest rates).
Joe Friday: “The facts, ma’am. Just the facts.”
As you can see, the 2-year yield and the fed funds have been quite correlated over the past 30 years. Typically, the 2-year yield leads the Fed Funds up and down.
But what happens when it reaches extremes? Because that’s what we have today.
The 2-year yield is trading at an extremely overbought level of the RSI. It is currently 76% higher than Fed Funds! The next closest example over the past 3 decades was in the 1990s when it traded 26% above the Fed Funds (before stalling and falling).
If history is our guide, the 2-year return may be approaching a certain peak. At a minimum, both gauges should see an average inversion. If so, it could mean a slowdown in rising interest rates. Stay tuned!
Chart of 2-Year Treasury Bond Yields vs. Fed Funds
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