The S&P 500 stock index has lost almost 20% of its value since February. Over in the bond market, alarm bells are flashing too. Particularly in a type of Treasury debt we don’t talk about very often — the two-year note. Investors in that market are particularly looking at what’s gonna happen to the economy and interest rates in the next two years.
Almost everyone in this economy is touched in some way by interest rates.
“It’s what people pay to lease their cars and their home mortgages and their credit card bills,” said Harry Mamaysky, a professor at Columbia Business School.
The Federal Reserve influences these interest rates based on what it thinks the economy needs. And what it does is gonna depend a lot on what tariffs do to the economy. Right now, economists expect tariff policy is going to hit in two big ways.
“One is it’ll probably push inflation up, at least for a while, and the other is it will push output and employment down,” said Bill English, professor of finance at Yale School of Management.
So, tariffs equal inflation. Tariffs also equal economic slowdown or recession. Here’s the tricky part: the Federal Reserve can’t fight both of those at the same time. It keeps interest rates higher to fight inflation. It keeps rates lower to fight an economic slowdown. The bond market has to guess which one the Fed will do.
“Markets seem to think that the Fed will respond more to the weak economy than to the high inflation,” said English.
Yields on two-year notes, which look two years out into the future, have dropped in the past couple of days. Investors think the Fed will have to cut interest rates more than expected because the economy is going to be worse than expected.
“Investors believe growth is going to slow and we are potentially going to enter recession,” said Ruben Hovhannisyan, a fixed-income portfolio manager at the TCW Group.
At the beginning of the year, markets expected the Fed to cut rates maybe once this year. But expectations have changed. “Something like two to three rate cuts by the end of the year,” said Harry Mamaysky.
So interest rates could fall by three-quarters of a percentage point this year. So far, Fed Chair Jerome Powell has said the Fed’s not in a hurry.
Collin Martin, a fixed-income strategist at Charles Schwab, said that may be because tariffs aren’t something the Fed can address. Schwab is a Marketplace underwriter.
“If the Fed were to cut rates, I don’t know how much that’s going to encourage companies to invest more,” said Martin. “I don’t think it’s the level of borrowing costs that’s necessarily affecting business behaviors right now. It’s the uncertainty.”
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