Bond Market & Fed Funds Rate Together Again

by: Babak

The market got spooked Wednesday because the release of the Fed minutes (April 30th meeting) showed a hawkish bent. First, I don’t think the market fell because of that. I’ve been cautious for a while now due to a number of technical and sentiment indicators.

But the reluctance of the Fed to continue cutting may not be a bad thing. For one, take a look at the comparison between the Fed Funds rate and the 3 month Treasury bill rate:

It is like the reunion of two lovers. (This is as romantic as a trading blog can get). These two financial metrics usually go hand in hand but for far too long there has been a historic dislocation between them. I first pointed this out last summer: Fed should cut rates immediately.

The fact that now we are seeing the bond market and the Fed Funds rate return to their normal behavior bodes well. Especially considering the financial turmoil we’ve endured so far. Believe it or not, at one point they were 133 basis points apart!

And now we are down to just 14 basis points.

I know this is a very simplistic way of looking at an incredibly complex matter but what can I say? I like simple things. I prefer to allow the market’s voice, through the 3 month T-Bill rate, show me where the interest rate should be. I definitely think they do a much better job than a committee of economists harrumphing around an oak table.

I would have preferred the Fed to have taken the rate below, even if just a smattering, the bond market set rate. But I doubt that will happen. We can just settle for the fact that instead of the previous pattern of running away from the Fed, the bond market is now heading towards it in what seems an inevitable reunion or perhaps, even
a crossing.

After almost two years of estrangement, that calls for a celebration.