“The two year is, in essence, the barometer for where the Treasury market thinks the Fed is headed,” said Quincy Krosby, chief global strategist for LPL Financial.
The central bank has so far been adamant that it plans to continue raising rates this year and that it sees no rate cuts until 2024 at the earliest. The Fed has raised its key overnight rate to a range of 4.25% to 4.50% from roughly zero a year ago. It will announce its next decision on interest rates Feb. 1, and investors are largely forecasting a rise of just 0.25 percentage points, down from December’s half-point hike and four 0.75 percentage-point hikes before that.
The Fed's goal in raising interest rates has been to fight inflation by making borrowing more difficult and to slow economic growth. The strategy, though, hurts investment prices and risks slowing the economy too much and causing a recession. The U.S. economy contracted during the first half of 2022 and grew slightly during the third-quarter. Economists expect GDP data to show slight growth during the fourth quarter. The weak GDP data is in sharp contrast to solid growth in 2021.
Recent economic reports have raised investors' hope that the Fed might succeed in taming inflation sooner than it realizes while inflicting less damage to the economy.
Annual inflation eased in December for a sixth straight month. The employment market remains strong, but workers' wage gains have slowed, easing pressure on inflation.
Consumer sentiment on inflation has also improved. A closely-watched survey from the University of Michigan showed that this month consumers lowered their expectations for inflation in the coming year to 4%, the lowest reading since April 2021.