The Fed Should Be Cutting Rates Soon

The best predictor of the Fed Funds Rate is the 2-Year US Treasury. This makes sense. The market aggregates all of the various market participants' opinions about where rates are going and lets them wager on it. Of course this indicator is better than a room full of PhD's, no matter how smart they are, in sorting out the direction of Fed policy. The metric is so good that the two rarely veer that far from each other. When they do, that is useful information. The 2-Year yield has recently begun to fall. As of the market close at the end of Q1, on March 31st of 2025, the gap is now 50 basis points. The historical average is -50 basis points.

Intuitively, the 2-Year yield should be higher than the Fed Funds rate, not lower. The creditworthiness of the Fed and the US Treasury is the same. The fact that the US Government currently pays 50 basis points more on its overnight rate than it does to borrow for two years is strange, temporary, and a signal. Cumulatively, the market is holding up an offside flag. The Fed is nearly 100 basis points offsides.

Look for the Fed to get back onside and begin to cut rates soon.