Wednesday’s interest rate decision by the Federal Reserve could be one of the most exciting ones the central bank has made in a long time. It could change what’s called the “front end” of the $27.6-trillion Treasury market.
The 2-year note and short-term Treasury bills due in less than a year make up the front end. That’s why buyers and traders pay attention to the yields on these government bonds: they often show how interest rates are likely to move.
FactSet data shows that as of Tuesday, the yields on 1-month T-bills TMUBMUSD01M 4.909% and 6-month T-bills TMUBMUSD06M 4.541% were mostly between 4.55% and 4.92%. The yield on the 2-year note TMUBMUSD02Y 3.613%, which shows how much people think it will cost to borrow money over that period of time, ended the day at 3.59%, which was the second-lowest level of the year.
Traders and investors are still arguing over whether the Fed will cut rates by 25 or 50 basis points for the first time this cycle. A 50 basis point cut would be the largest move by the central bank in 16 years. Even if the central bank doesn’t change its interest rate on Wednesday, some strategists say that the answer to that question will show how much the Treasury curve needs to be repriced.
LPL Financial’s top fixed-income strategist, Lawrence Gillum, said, “The front end will have to move one way or the other.” Gillum is based in Charlotte, N.C. “The 2-year rate could go up to 3.75% or more if we get a 25-basis-point cut.” Or, if we get a 50-basis-point cut, it could drop right away to 3.50% or less.
He also said on the phone on Tuesday that the Fed’s updated interest-rate projections, which include 2025 and 2026, could be more important to market players than the size of Wednesday’s rate cut. This is because the central bank’s forecasts include those years.
Market players care about the 2-year yield because, compared to 10-year yields (TMUBUSD10Y 3.645%) and 30-year yields (TMUBUSD30Y 3.955%), it gives the best picture of where interest rates should settle once the U.S. economy gets over any short-term slowdown.
The 2-year yield became one of the most interesting parts of the U.S. government debt market in 2022, when the Fed started raising rates more quickly than it had in about 40 years.
Since interest rates are going to be lowered on Wednesday, the 2-year rate could send a message to buyers in stocks and the rest of the market. People in the market will probably look at the direction of the 2-year yield after the Federal Reserve meets to decide if there is a greater chance of a U.S. recession or if the Federal Reserve can successfully lower interest rates ahead of time to keep the economy from going into a slump.
Will Compernolle, a strategist at FHN Financial in New York, said that he thinks the whole Treasury curve will need to be repriced, no matter how much the Fed cuts interest rates on Wednesday.
Longer-term rates “will recalibrate to the tone of what the SEP [Summary of Economic Projections] shows,” Compernolle said on the phone on Tuesday. Short-term rates will need to change to reflect the Fed’s new interest rate path.
