The Battle Between T-bills and the 2-year note: Fed Tightening is likely over, pause or easing cycle likely ahead
If all we know about markets was based on the relationship between T-bills and the 2-year note, we have arrived at an important junction. T-bills and the 2-year note are battling over whether or not the front end of the yield curve will be positive, or inverted (Chart 1). In some ways, this battle is already over as far as the rest of the market should be considered. It is very rare for the relationship between T-bills and the 2-year note to be this flat or inverted. As Chart 2 shows this has only occurred a handful of times since the early 1980’s – when the Fed is raising rates and monetary policy is getting tighter. The significance for investors today is that when it occurs, the Fed is usually on the verge of a pause in the rate hike cycle, or an easing cycle is about to begin. On the surface this would appear to be favorable for risk assets – in the majority of cases risk assets have tended to do well after the tightening cycle has paused or ended – but not always. The exceptions to this rule were pretty bad (think 2000 and the set-up for the 2008 financial crisis). Nonetheless, there is cause for optimism today – the world has many notable and obvious challenges, but the excesses that existed in the markets in 2000 and in the years right before the 2008 Financial Crisis are not apparent today. If a pause or an easing cycle is before us, it is more likely to favor risk-on trades rather than risk-off trades.
1 and 2 Year Treasuries
Source: Bloomberg, accessed 1/4/18
1 and 2 Year Treasuries – Historical
Source: Bloomberg, accessed 1/4/18
Federal Funds Target Rate
Source: Bloomberg, accessed 1/4/18.
Jonathan Lewis
Chief Investment Officer
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