The gap between two- and five-year Treasury notes is expected to narrow further in the coming months as the Federal Reserve continues to raise rates, according to interest-rate strategists. While the Treasury curve typically flattens in a rising-rate environment, they said it has remained steep since the Fed began raising rates earlier this year and it should begin to flatten now because the Fed Fund rate is approaching a more normal level of 3% to 4%.
With the Fed Funds rate at 1% last August, the spread between the two- and five-year Treasury notes was 160 basis points. Today, with the base rate 50ps higher, the spread has narrowed to 90bps. The spread should get even narrower but tightening will likely be limited to the next two to three months, predicted William Prophet, interest-rate strategist at UBS.
Given expectations the Fed will raise rates as high as 2.25% by the end of the year, the spread between two- and five-years could shrink to 80 basis points, according to Ken Fan, rate strategist at ABN AMRO. He expects yields of 2.85% for the two-year and 3.65% for the five year.
