- 2-year government bonds surged over 4% after FOMC meeting
- The 2-year note could now be heading for around 4.5%
- This should lead to a lot of stock market volatility
The Treasury rate surged above 4% after the FOMC meeting on Sept. 21 and that may not be over for a long time. The FOMC meeting revealed many details and set a possible path for monetary policy for the remainder of 2022 and 2023. The rate was more hawkish than expected, paving the way for a 2-year rate that could soon break the 4.5% mark.
The price is now just catching up to the December 2023 Fed Funds Futures contract. It has been trading almost in step with the December contract since early August, trading about 20 basis points lower.
If the market believes that the FOMC summary of economic forecasts and interest rates are headed for 4.6% of the federal funds rate, December contracts need to rise to that 4.6% level over time. Based on this current spread between the 2-year and December contracts, the rate should also be approaching 4.4% to 4.5%.
The technical chart also suggests that the 2-year note could rally even higher by 4.15% from its current levels. There is only one technical resistance level, around 4.25%, and no natural resistance until the 2-year price reaches around 4.65%. This wide range of resistance is due to how quickly interest rates fell in 2007 as the market began to price in the rising risk of a recession.
Rising interest rates at the front end of the curve will be overall negative for equities as credit spreads widen. A ratio of the iShares 1-3 Year Treasury Bond ETF (NASDAQ:) and the iShares iBoxx High Yield Corp Bond ETF (NYSE:) mimics the Markit CDX high yield spread. Comparing the ratio shows that when these high yield spreads widen, the VIX rises, suggesting that stock market volatility is increasing.
Of course, higher volatility isn’t good for stocks in general or higher-beta names. Unfortunately, these may be names that have already suffered badly, like many of the pandemic names that many investors have fallen in love with.
Many of these stocks are already heavily down, even if their valuations make more sense today than they did about a year ago. If the market sees a spike in volatility in the short term, these stocks won’t be immune.
Over the next few weeks, it seems likely that the 2-year rate could go much higher. As these rates continue to rise, it is highly likely that they will spill over into stocks in the form of increased volatility and lower prices.
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