The two-year has broken through to the other side

Have we finally begun seeing the normalization of interest rates in U.S. Treasuries? Although we’ve seen sudden rises in interest rates before, we haven’t seen a precipitous rise like we’ve seen in the last month.

Although we often focus on the ten-year Treasury as the barometer of interest rates, the two-year Treasury is our focus at this point. The two-year Treasury jumped above a key psychological hurdle on January 12, 2018, marking the first time since 2008 that it yielded above 2 percent. In particular, as the graph below shows, in 2016 the two-year never eclipsed the 1 percent mark. Prior to the election, yields had largely been the same as those that we endured through the previous ten years.  

There are a variety of factors that have finally allowed interest rates to rise recently with lower regulations on businesses, Federal Reserve rate hikes, fiscal policy, consumer confidence, and economic activities being just a few. However, recent inflation numbers showing a greater probability of future rate hikes appears to have been the final factor that drove yields above the 2 percent threshold. While the Fed has been focused on gaining control over inflation and full employment, inflation has taken center stage lately since employment is near full at 4.1 percent unemployment as of December 2017.  

Although we have seen smaller spikes in yields that eventually came back down in the past, this one should be viewed as more permanent. With the five Fed increases in the last two years serving as an illustration of how low short-term rates can go, the only logical place for rates to go is higher. How much higher is yet to be seen but we view this as a positive development. Higher rates can provide reasonable returns on short term investments for savers and those depending on a fixed income.