The slope of the yield curve between say 0 and 2 years has soared since October, the 2-year yield going from ~0.35 to ~0.85 with short term rates still zeroish.

Seems like that's discounting an awful lot of hikes by the fed over the next year or two.

This is bait to see if Rocky will tell me what it means.

Victor Niederhoffer responds: 

Before the erudite polymath sets us straight, I can tell you that it means the expected average of the funds rate for the next 2 year is 1.70%

Rocky Humbert takes the bait:

Last April, the 2 year note reached 1.11 (0.85% last). So, we're still about 30 basis points below last April– which incidentally was a great time to short stocks and buy bonds… One obviously wonders whether we'd be 30 - 50 basis points higher right now but for the QE2 ??

Vic is correct, but there's a nuance because the mean is different from the path. The last six Fed Funds futures from June 2012 to Jan 2013 predict fed funds at between 1.00% and 1.83%; and the front of the Fed Funds strip Feb11 to Feb Sep 11 all have Fed funds between unchanged So the "steepness" is mostly in the back contracts. That is, Mr. Market believes that the fed will not move until late 2011 or early 2012 at the earliest. And then it will tighten 200 basis points fairly quickly. I think the market is consistent with Pimco's most recent stated view…

It's really hard for me to get excited about a 2 year note at 0.84% when the CPI is running at more than double that. And, the MIT Billion Price Project is predicting an accelerating CPI over the next few months.


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