A SHORT PATH TO RECOVERY / THE WALL STREET JOURNAL

Heard on the Street

A Short Path to Recovery

A Rise in Two-Year Bond Yields Could Signal the End of Easy Money

By Richard Barley

Jan. 13, 2014 10:01 a.m. ET


Investing should be all about the long term. But investors should also keep an eye on what is happening at the short-term end of government-bond yield curves. This year, two-year rates may offer important clues on central-bank policy and the depth and sustainability of the recovery.

In 2013, the big moves in yield came at the longer-dated end of the curve, marking the end of a 30-year bull market in government bonds. Ten-year Treasury yields rose more than a percentage point as the U.S. Federal Reserve signaled the beginning of the end for its massive bond-purchase program. U.K. gilts moved by a similar amount as the economy began to motor. And even 10-year Bund yields climbed despite anemic growth in the euro zone.


But two-year rates were much more resilient. In the U.S., two-year yields now stand at 0.38%, in the upper part of a range that has persisted for 2½ years now. 

Markets are apparently satisfied that tapering of bond purchases doesn't mean the start of rising interest rates. German two-year Bund yields stand at just 0.18%, with the European Central Bank signaling that its next move could be to loosen policy further to combat extremely low inflation. Only in the U.K., where the Bank of England has struggled to convince markets that rates are on hold potentially for years yet, have two-year yields risen markedly, to 0.49%.

It seems likely that low two-year yields may persist for some time yet. With inflation subdued and central banks clearly wanting to be sure that the economy is recovering robustly, policy makers seem in no hurry to raise rates—a development to which two-year yields would be highly sensitive. But over time, and particularly if economic data is strong, the central-bank mantra of "lower rates for longer" should start to lose its grip on markets.

J.P. Morgan JPM forecasts two-year Treasury yields should start to move concertedly higher in the second half of the year, reaching 0.8% in December 2014, even with the Fed Funds rate remaining nailed to the floor. A sustained rise in two-year rates would be a powerful signal to investors that this time the recovery is for real—and that the days of ultra-easy money are numbered.