The difference between the two-year Treasury yield and a key interest rate set by the Federal Reserve is the narrowest from the depths of the sale of the coronavirus market, a potential sign of financial system stress.
The two-year Treasury yield, which closed 0.13% on Monday, is 0.013 percentage points above the excess reserve interest rate, or IOER. It traded up 0.105% earlier in February. The Fed pays banks reserves held above those required by central bank regulatory policy as part of its effort to maintain liquidity in the financial system.
When the coronavirus brought down the markets and the economy in March, the Fed reduced the OER 1 percentage point to 0.10% —along with other interventions— to strengthen short-term lending markets and give support for economic activity. The difference between the IOER and the two-year yield has typically been more than 0.05 percentage points since the Fed cut the rate to its lowest level in March.
Traders said lowering this spread reflects short-term debt appetite as investors take out safe assets and park their cash. It also highlights a key point of tension in financial markets: the extent to which Fed support for markets brings asset prices to unsustainable levels and the vulnerability it leaves in bond markets and other areas exposed to sharp investments.
Analysts have been looking at the results of Treasury auctions to assess whether rising tax spending and rising Treasury bond supply will drive Treasury prices down in the short term and increase yields. So far, this has not happened. But bond traders are worried that inflation may rise in the coming months and years as the government prints money to support the economy and cover future borrowing costs.