Thanks to Powell & Co., the month of November has gotten off to an inauspicious start for the money and bond markets. I recently blogged about Fed Funds and Treasury yields becoming a “four”gone conclusion , and now that these milestones have been met, you have to ask yourself the question: is five becoming the new four?
It all begins with where the terminal rate of the Federal Funds target range is going. At the September FOMC meeting, the Fed’s own median estimate placed the level at 4.6%. However, at the November FOMC meeting presser, Chairman Jerome Powell provided an update, stating that “incoming data suggests the September dots should be higher.” What, exactly, is higher? Well, if you look at the June 2023 Fed Funds Futures contract, the level was 5.14%, as of this writing. In other words, the market is pricing in a terminal Fed Funds target range of 5%–5.25%.
Fed Funds vs. Treasury Yields
If this is where the Fed is headed in this rate hike cycle, where does that put the key U.S. Treasury (UST) 2-, 5- and 10-Year yields? Typically, these maturities will trade with a ‘spread’ or yield level over Fed Funds, especially during a tightening backdrop. This is exactly what investors have witnessed in this go-round as well (see graph), and there is nothing to make me to think this trend won’t continue until the Fed pivots to a ‘pause and cut’ monetary policy phase.
Based on Powell’s presser, the Fed is guiding the markets for a potential ‘higher for longer’ Fed Funds scenario, underscored by his comments that rate hikes still have “some ways to go” and it would be “premature to pause,” let alone to think of cutting.
So, let’s look to history for some possible guidance for UST yields. The last time the Fed took Fed Funds to 5% or higher was the 2004–2006 rate hike period. At that time, the peak readings for UST 2- and 5-Year yields reached 5.28% and 5.23%, respectively, while the 10-Year topped out at 5.29% in mid-2007.
The aforementioned UST yield levels are not meant to be an outright prediction. There is no doubt the Fed seems to be leaning toward a slower pace of rate hikes, but the terminal rate sure looks like it’s going to be headed in the 5% direction. Against this backdrop, history suggests 5% yield handles could be forthcoming for short-term Treasuries, at a minimum, with intermediate maturities such as the 5-Year note not too far behind. At this point, I’m not ready to make that assumption for the UST 10-
Year yield (at least not yet), but it does appear as if some renewed elevation moving back into the 4.25%–4.5% trading range (if not a bit higher) is a reasonable scenario.
Stay tuned…things change quickly!
Originally Posted November 9, 2022 – Is Five Becoming the New Four?
Disclosure: WisdomTree US
Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. U.S. investors only: To obtain a prospectus containing this and other important information, please call 866.909.WISE (9473) or click here to view or download a prospectus online. Read the prospectus carefully before you invest. There are risks involved with investing, including the possible loss of principal. Past performance does not guarantee future results.
You cannot invest directly in an index.
Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, real estate, currency, fixed income and alternative investments include additional risks. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please see prospectus for discussion of risks.
WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from WisdomTree US and is being posted with permission from WisdomTree US. The views expressed in this material are solely those of the author and/or WisdomTree US and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.