Long Term Perspective

The spread between the 3-year Treasury note and the federal funds rate averaged 27 basis points in the 1980s – a relatively low spread. This was a period of high interest rates and (relatively) high inflation. This spread in the 1990s averaged 83 basis points.  The spread between the 3-year note yield and the federal funds rate averaged 58 basis points between 2000 and 2011.

Short Term Perspective

During periods of stable monetary policy, it is not unusual to see average yields on 3-year notes to run at least 100 basis points over the fed funds rate target. But when markets expect changes in monetary policy, this spread can move significantly. As economic conditions improved in 2003 and 2004, bond investors expected that Federal Reserve officials would increase the fed funds rate target from its historically low rate of 1 percent. The Fed did not begin to increase the funds rate target until June 2004. Rate hikes in 2004, 2005, and into 2006 were anticipated by market players and did not come as a surprise. Over the 2007 through 2008 period, the Fed cut the fed funds target rate sharply – from 5.25 percent in mid-2007 to the current range of zero to 0.25 percent.  The Fed’s slashing of its policy rate has turned the spread positive since early 2008.  The 3-year note yield rose moderately in early 2011 on favorable economic news and a temporary lessening in concern over European sovereign debt.  But recently those factors reversed as the economy turned sluggish in mid-2011 and into 2012 and worries about Europe worsened. In October, the 3-year note firmed 3 basis points to 0.37 percent.

Values shown reflect monthly averages.