Narrowing 2- and 10-year spread with high rate hike probability

Mismatch in Fed actions and market movements

It’s interesting that we’re seeing the spread between the 2- and 10-year notes narrow, increasing recession probabilities and tapering inflation expectations. It seems that after the last rate hike and the impending current rate hike on Wednesday, that the market is suggesting the Fed is pushing the accelerator too hard. As the 2- and 10-year spread compresses in light of the impending rate hike, it's safe to assume we could be approaching the natural rate of interest.

Narrowing 2 and 10 year spreadFigure 1: Narrowing 2 and 10 year spread

Even though the number of expected rate hikes next year has declined to 1, we’re still seeing a 76% probability of a rate increase this week. Given the volatility sparked by the last rate hike, we could be in for at least continued volatility, just an interesting data point to keep in mind going into year end. Either way, with the valuation multiple compression we've seen over the last few weeks, if recession fears start to abate, we could be lining up for an eventful 2019.

High Probability of Rate HikeFigure 2: High Probability of Rate Hike