Hike, Pause, Cut

It’s been a rough couple of weeks (months/years?) for one of the most powerful entities in the entire world. First, they were too late to raise rates. Then they raised them too much, leading to some of the biggest blowups in banking that this country has ever witnessed.

You would think that the recent events would cause them to pause and reassess the damage, but no, they went ahead with another 25 basis points anyway even though the market is telling them to stop, and maybe even cut.

As the chart below shows, the 2-year treasury rate and the fed funds rate tend to move together.

But sometimes their paths diverge, when the market, which controls the 2-year, disagrees with the fed, which controls the fed funds rate.

A great example of this was when the fed was late to raise rates through 2021 into 2022. The 2-year went from basically zero to 150 bps before the fed finally got off zero.

The fed doesn’t follow the 2-year because of some gravitational pull, just that the market tends to see things before they do. And right now, as you can see, the market is telling the fed to chill, which historically hasn’t been great.

Warren Pies tweeted this graphic which shows the difference between the 2-year treasury and the fed funds rate. Every time this goes negative, something nasty followed.


This chart shows a clear history of the fed going too far. Once they stop, they keep going until something breaks. And judging by their recent actions, the largest bank failure since the great financial crisis is evidently not enough. They want more.

I’m not a fed hater. I have respect for the institution and how difficult their job is. The pandemic dealt them a seven-deuce off suit, which clearly they weren’t responsible for. But then they went all in on the river, and the market called their bluff.

It’s not a question of if the fed cuts. The only question is when and why.