The Treasury market is sending up a warning flare, indicating the Federal Reserve may have made a “policy mistake” Wednesday as it continued to hike rates into an economic slowdown and a banking scare, a closely followed Wall Street analyst warned.
“Yesterday’s Fed decision was the 2nd rate hike which propelled 2-year yields (forward-looking indications) LOWER as the Fed raised rates. Historically, divergent paths between Fed Funds and 2-year indicate a policy mistake,” said Jeff deGraaf, founder of Renaissance Macro Research, in a Thursday note (see chart below).
Renaissance Macro Research
The yield on the 2-year Treasury note
TMUBMUSD02Y,
declined by 21.2 basis points, or 0.212 percentage point, to a 7 1/2-month low of 3.727% on Wednesday, its largest one-day drop since March 17, according to Dow Jones Market Data. Yields move in the opposite direction of price.
Stocks were under pressure on Thursday, with the Dow Jones Industrial Average
DJIA,
slumping around 275 points, or 0.8%, while the S&P 500
SPX,
lost 0.6%. Both indexes threatened to extend a losing streak to four straight sessions. Worries over the banking sector and a potential recession continue to dog equities, analysts said.
The Federal Reserve delivered its 10th consecutive rate increase Wednesday and indicated that a breakneck cycle of hikes may be due for a pause depending on incoming data, but Chair Jerome Powell said rate cuts remained at odds with the central bank’s inflation outlook.
See: Traders ignore Powell and begin pricing in a Fed rate cut as soon as June
In 2021, it was a surge in the 2-year yield that signaled the Fed had fallen behind the curve, keeping rates low as inflationary pressures built up. DeGraaf noted that 2-year yields broke out in June 2021, nine months ahead of the Fed’s first rate hike in March 2022.
Policy mistakes “always manifest themselves through the short-end of the yield curve,” deGraaf said. He noted that when the 2-year yield peaked above the 5% threshold in March of this year, the top of the fed-funds rate was at 4.5%, now the 2-year yield is near 3.8% while the fed-funds rate is at 5% to 5.25%.
“History does not look kindly upon these aggressive policy measures that vary wildly from the market’s message,” deGraaf warned.
