The bond market is sending a clear message: it’s time for the Fed to start thinking about rate cuts. The chart above compares the 2-Year Treasury yield with the Federal Funds Rate, and right now, the 2-Year is trading well below the Fed’s upper limit—by about 56 basis points.
Why does that matter? Because the 2-Year yield tends to lead the Fed. It’s often seen as the market’s best estimate of where short-term rates should be heading. When the 2-Year drops below the Fed Funds Rate, it’s usually a sign that investors think the Fed is too tight and will need to ease up.
We’re not quite at the extreme levels we saw last summer, when this same spread dropped to -1.67 percentage points and helped push the Fed into cutting rates by 50 basis points initially (and 100 basis points total). But we’re heading in that direction again. If next month’s job report comes in soft, expect this gap to widen—and the pressure on the Fed to cut rates to intensify.
Bottom line: The bond market is laying the groundwork for rate cuts. If the economic data keeps softening, the Fed may have no choice but to follow the market’s lead.
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