Long Term Perspective

Fluctuating yield differentials between the 2-year note and the 10-year note reflect changes in the economic environment. When the spread between these two securities has narrowed, it has historically reflected softening in economic activity – and sometimes even recession. When the spread widens, it reflects a period of stronger economic growth. The gap between 10-year and 2-year note yields widened in 2002 and 2003 suggesting economic growth was on the horizon. In 2004, the gap narrowed as the yield curve flattened. The spread narrowed further in 2005 and 2006 and was nonexistent during 2007 with the 2-year note even edging incrementally above the 10-year yield. Flight to quality over subprime concerns during the second half of 2007 kept rates low along with the belief that the Fed would be easing further. But in mid-2008, some market participants became skeptical of the Fed's inflation fighting resolve and long rates temporarily headed back up. During the second half of 2008, rate slashing by the Fed, recession, and flight to safety were the reasons rates fell. But during 2009, long rates reversed and headed back up on supply concerns related to funding the federal deficit. During 2010 and 2011, the 2-year and 10-year Treasury yields swung sharply due to on-and-off flight to safety on worries over European sovereign debt. These rates leveled off at low levels in late 2011 and 2012 before the 10-year spiked to nearly 3 percent before easing and holding in the low 2 percent range in fourth quarter 2015, the result of soft economic growth and low inflation.

 

The Fed's prior rate cutting cycle began in mid-2007 as the Fed cut the fed funds target rate from 5.25 percent to a target range of zero to 0.25 percent set on December 2008. It wasn't until December 2015 that the Fed started what it expects will be a gradual and lengthy tightening cycle, raising the funds rate by a 1/4 point to a range of 0.25 percent to 0.50 percent.

 

 

Short Term Perspective

In 2012, soft economic data and renewed worries about European sovereign debt bumped longer maturity rates down. The Fed's pledge to keep policy rates exceptionally low also weighed on rates. In late 2012 and early 2013, improved economic news led long rates to firm. But in spring 2013, longer rates eased on softer economic indications. Then long rates rose significantly on market chatter that the Fed would taper asset purchases in autumn 2013. Long rates rose further in early 2014 following the December 2013 taper announcement. But in late 2014 through the first half of 2015, rates eased on softer global growth and flight to safety over geopolitical events. Heading into and immediately after the Fed's liftoff in December 2015, the yield on the 2-year note began to rise, moving from 0.90 percent to touch 1.00 percent. The 10-year note yield was steadier, holding near 2.25 percent before and after liftoff.