How the Bond Market Prices In Fed Policy

Chart of the Week: How the Bond Market Prices In Fed Policy

July 29, 2022

Traders and investors spend a lot of energy trying to predict the Federal Reserve’s actions. The Fed also spends a fair amount of effort telegraphing what it is planning to do; an unwritten policy is to try to avoid “surprising” the market. The result? By the time the Fed acts, bond traders have more often than not already priced in the move.

You can see this in the chart below, where I’ve plotted the yield of the three-month Treasury bill alongside the fed funds rate (specifically, the upper bound of the Fed’s target range). The two rates largely move together—no surprise there. The key insight, though, is that the T-Bill’s yield leads the fed funds rate.

So the Fed hiking rates yesterday made headlines, but for bond investors it was already old news.

This chart shows the yield on the 3-month T-bill from the end of 2021 through July 27, 2022 as well as the upper bound of the target fed funds rate.
Note: Chart shows daily yields for three-month Treasury bills alongside the upper bound of the Federal Reserve’s target range of the fed funds rate from 12/31/21 through 7/27/22. Source: The Federal Reserve Bank of St. Louis.

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