The 2-Year Treasury Yield has never been this high in such a short period of time, and this is due to the Fed’s recent increase in interest rates. Interest rates affect investments dramatically. They have a direct effect on capital markets; mainly the stock market and the bond market. Raising rates reduces the price of stocks. It makes it difficult for companies to grow because stock investors become more reluctant to bid up stock prices because the value of future earnings looks less attractive. Interest rates affect bond prices and yields. High-interest rates make the price of existing bonds fall. This is bad news for the bondholder because of the inverse relationship between bond yields and bond prices. When yields rise, prices of current bond issue fall. This leads to a decline in demand for bonds and issuers of new bonds must offer higher yields to attract buyers, which reduces the value of lower-yielding bonds already on the market.
Source: U.S. Department of the Treasury
The 2-Year Treasury Yield increased recently, which currently reduced demand for bond investments. The 2-Year Treasury Yield rose to 4.04% and this could be potentially signaling to us that there is a recession coming ahead. In the typically tame market for government bonds, investors have been left reeling from some of the most chaotic trading conditions they have ever seen, entrenching concerns about the broader economy since the collapse of SVB. Government bonds, also called Treasuries, are the bedrock of global markets. Hence, a rise or fall in Treasury yields, which move in opposite direction to their price, can ripple through to everything from mortgages to company borrowing—affecting trillions of dollars’ worth of debt.
The volatility in the bond market has been extreme as we can in this figure and we don’t expect these swings to change anytime soon, in particular as investors consider more economic data and changing outlooks for everything from the Fed’s plan for interest rates to whether the financial system has stabilized. But how the rise in the 2-year Treasury yield may signal a potential recession?
Source: Y Charts
In early March 2023, yields on U.S. Treasury securities stood at or near the highest levels seen in years. However, in just a matter of days, as issues emerged with the bank turmoil, investor sentiment changed, as many investors fled into the relative security of Treasury bonds, which led to a significant drop in bond yields. This was before the Feds raised rates on March 22nd on an 0.25-point increment. Although the 2-year Treasury rate and interest rates tend to move together, they are times when they do not follow along. According to investor Michael Batnick of Ritholtz Wealth Management, the federal interest rates do not follow the 2-year treasury rates because of some gravitational pull, and this divergence is an indicator that the market is signaling to the Federal Reserve to tame interest rates because some markets are showing unexpected resilience.
The Federal Reserve tends to push it too far sometimes. The current situation is delicate because the Feds want to bring inflation at all costs, including inflicting pain on the economy if necessary to tame inflation. But the market seems resilient as stock prices continue to rise despite high rates. For Batnick, it is time for the Feds to pause on interest rates. The question then is, what will happen if the Feds pause on interest rates? Inflation will likely surge again because demand will rise again since the job market remains steady. If inflation rises again, then the Feds will have to re-increase rates again to prevent inflation from surging further. On the other hand, if the Feds continue to increase rates on a 0.25-basis point, they will surely trigger the recession that we’ve been all waiting for. The current financial condition is a dilemma that only time will be able to solve.