2 Year Treasury Bond Yield vs FED Funds RateThis post is intended to show the current gap between the market for the 2 year US treasury yield on bonds and the official funds rate, and why the market is forcing central banks hands into raising interest rates when the market is in such a fragile state in ability to support and maintain debt at heighten interest rate levels.
Simply put, bond market are crashing (i.e. no one wants to hold onto treasure bonds at present because they are yielding very little / people are losing faith in governments ability to uphold their debt obligations / competition in the market for credit is rising etc. etc). All these factors play into buying selling behavior and is repriced in the market.
As a bond or lone has a fixed bond or repayment structure ($amount), if the capital price the bond changes hand in the secondary market is lowered, the effective yield from the bond goes up. For example if a bond is made for $10,000 and requires a 10% interest rate (i.e. $1,000) per specified period, then if this loan / contract / bond (same thinking) is changed hands in the secondary market and sold for $5,000, the new own still receivers the conditions of the prior arrangement. Hence $1000 per period. As the price was $5,000, then the interest or Yield on that bond is now 20% (i.e. $1000 / $5000 x100 = 20%).
As new credit is competing against the secondary market (i.e. you could loan your money out to a new loan or you could buy an existing loan (Bond) on the secondary market), this is how the bond market drives interest rates.
Complicated but hope this makes sense.
in summary, falling bond prices cases rising yields or interest rates. Raising bond prices causes lower interest rates.
Central Banks play in this market as a market participant with an unlimited check book (this is how new base currency or M1 enters the market ( QE - Quantitative Easing) or is removed from the currency supply (QT - Quantitative Tightening ).
If Central Banks want interest rates to rise, they flood the market with bonds, dropping the market prices with excess supply and causing yields to rise. If they want interest rates to drop, they soak up supply in the market of bonds, causing prices to rice and yields (interest rates to drop).
This process is called 'Open Market Manipulation'. AKA planned market manipulation at it's best.
www.federalreserve.gov
The 'official funds rate' is just a forecast which shows how the Central Bank plans to manipulate the bond market until it's next meeting.
Interest rates on loans / bonds etc should be viewed as a measure of risk of default. High interest rates reflect the reward on offer for lending your currency out and the risk you will not get it back.
In short, Market conditions (such as inflation ) changes investors view on risk. When Central Bank manipulation of the bond market goes our of whack with the risk to lending in the market, we see large gaps between the yield curves on bonds between the official funds rates issued by the Central Bank .
This gap is clearly shown this chart, comparing the 2 year yield against the Official FED Funds rate (the interest rate you hear about on the TV).
History shows the 2 year is a good leading indicator on what Central Banks will do with interest rates.
Make no mistake, the market and inflation is forcing Central Banks to raise interest rates.
I very much question the robustness of 'the economy' to handle higher interest rates at present.
