The Federal Open Market Committee (FOMC) voted to start increasing the target range on the Federal Funds Rate last week, moving the range from 0-0.25% to 0.25-0.50%. They also guided toward the possibility of six more increases by the end of 2022. These changes in policy stance have led to increased conversations about the future projection of long-term interest rates. Our view coming into this year had been that the rate of change for economic growth and inflation would decelerate which would ultimately lead to lower long-term interest rates and flatter yield curves. This pattern has played out in the last two periods when the FOMC was increasing interest rates and there is evidence that a similar trend is developing now.
The FOMC statement announcing that they had increased the target range for the Federal Funds Rate was released at 2:00pm on Wednesday, March 16th. The ten-year Treasury topped out at 2.24% and ended the week at 2.15%. The thirty-year Treasury topped out at 2.53% and ended the week at 2.42%. The two-year Treasury got to 2% following the announcement and ended the week at 1.94%. The one-month Treasury Bill briefly went above 0.23% and ended the week at 0.19%.
This could be a sign that investors think interest rates will start to decline as the FOMC continues to increase the Federal Funds Rate, or that getting to six more increases this year will be a challenge. The futures market for shorter-term interest rates continued to invert last week, a sign that investors are increasing the probability that the FOMC will have to reverse their policy stance and begin cut to rates after 2022.
The moves last week continued a trend of flatter yield curves that has been in place for the last year and has been gaining momentum in 2022.
This pattern of flattening yield curves has occurred before during periods of time when the FOMC was increasing the target range for the Federal Funds Rate. From 2004-2006, the FOMC was consistently increasing the target range by 25bps at each meeting. This led to higher rates for short-term bonds, like the three-month Treasury Bill and the two-year Treasury. The longer-term bonds (5, 7, 10 year) did not increase as much and eventually started to decline. This led to a flatting curve and eventually an inverted yield curve as the three-month and two-year yields were higher than longer-term yields.
The last time the FOMC was consistently increasing the target range was 2017-2018. Long-term yields increased in 2017 and into the third quarter of 2018 but at a slower pace than two-year yields, leading to flatter yield curves. In the last few months of 2018, longer-term interest rates started to decline, and yield curves eventually inverted in 2019.
The flattening of interest rate curves during periods of time when the FOMC is increasing the target range is driven by the difference in factors that influence the yields of short-term and long-term interest rates. The closer a maturity is to the target funds rate, the more that yield is determined by changes in the targeted range. The yields for the longest maturities are determined by expectations for future economic growth and inflation. During periods of increases in the targeted range, the shorter-term maturities increase as the range, and expectations for the future range, increases. Longer-term rates tend to start declining as the expectations for economic growth and inflation decline. We expect this period to be the same with yield curves continuing to decline and invert, as the rate of change for economic growth and inflation slow, while the target range increases.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC