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The spread between the two-year Treasury yield and a key interest rate set by the Federal Reserve is the narrowest since the depths of the coronavirus market liquidation, a potential sign of stress in the financial system.
The two-year Treasury yield, which closed at 0.113% on Monday, is 0.013 percentage point above the excess reserve interest rate, or IOER. It traded as low as 0.105% earlier in February. The Fed pays banks on reserves held in excess of those required by central bank regulatory policy as part of its efforts to maintain liquidity in the financial system.
When the coronavirus tipped the markets and the plunging economy in March, the Fed slashed the IOER by 1 percentage point to 0.10% – alongside other interventions – to shore up loan markets. short term and support economic activity. The spread between the IOER and the two-year yield has generally been over 0.05 percentage point since the Fed cut the rate to its lowest level ever in March.
Traders said the narrowing of this spread reflects appetite for short-term debt as investors gobble up safe assets and park their cash. It also highlights a key point of tension in financial markets: to what extent is the Fed’s support to markets pushing asset prices to unsustainable levels, and to what extent does that leave markets bond and other areas exposed to sudden reversals.
Analysts looked at the results of Treasury auctions to assess whether an increase in budget spending and an increase in the supply of Treasury bills would cause Treasury prices to fall in the short term and yield higher. So far, this has not happened. But bond traders fear inflation will rise in the months and years to come as the government prints money to support the economy and cover future borrowing costs.
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