2 Year Treasury Yields Crumbling

Remember when you were in school and there was always that kid at the front of the class who would always have the correct answer when the teacher called on him? Then the teacher would call on another kid sleeping in the back of the class and that kid at the front would turn around with that smug grin on his face and roll his eyes when the lazy moron at the back would give some sort of stupid answer. Just for the record, I was neither. I slept at the front of the class.

That’s sort of like equities vs. bonds. The bond guys are at the front of the class with their hand up anytime the market asks a question. The equity guys are at the back of the class wondering what is for lunch and playing triangle football. Well, maybe not that much of an exaggeration, but I think you get my point.

Check out the latest on the 2 year treasury. Trading with a yield of 1.55% today. It has been in a long descent since June 2007. That’s months before the first fed cut in 2007. In fact, on June 28, 2007, the Fed decided to keep its Fed Funds target rate at 5.25%. If you read the press release, this statement will probably jump out at you too.

Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters.

So what did the kid at the front of the class do? He started buying 2 year treasuries. Then, on August 7, 2007, the Fed decided to keep the Fed Funds rate at 5.25% again. What did the kid at the front of the class do? He bought 2 year treasuries. What did the kid at the back of the class do? He sold equities.

But on August 17, 2007 when the Fed cut it’s discount window rate, the kid at the front (Bonds) bought 2 year treasuries. The sleeping kid at the back of the class (Equities) started buying stocks. That’s where things started to really diverge before they started trading in lock-step with one another again on October 16, 2007. So what happened on October 16, 2007? Well the Fed released the minutes of its discount rate meetings from August 16 through September 18, 2007. In other words, the kid in the back of the class got an ‘F’ and was beaten by his father who then went and had a meeting with the teacher and she suggested he move up to the front of the class right next to the “Bond” kid. That lazy kid has been copying off of the Bond guy ever since.

But eventually, the father will forget about the punishment, the teacher will become complacent and the kid will move once again to the back of the class. However, the bond kid will still be vigilant…and probably beaten on the playground.

So what’s the moral of the story? The bond guys are almost always right. They may not be the coolest guys, but they are so seldom wrong. I want them as my friends. Just don’t tell my other friends.