New York, March 30 (Bloomberg) -- The Federal Reserve, whichhas cut interest rates three times already this year, is almostfinished, if history is a guide. At 1.27 percentage points, the difference in yield between thetwo-year note and the 30-year bond, which when put on a graphis called the yield curve, is more than it's been in five years. Thecan mean only one thing, analysts say -- that interest-rate cutsare coming to an end. ``We've had three big rate cuts already this year, and probablywill get another in May, so 30-year bond yields are starting toreflect the possibility of an economic rebound and faster inflation,which means'' an end to lowering rates, said Tony Crescenzi,chief bond strategist at Miller Tabak & Co. Not since Feb. 27, 1996, when a round of Fed rate cuts hadcome to a close and the difference between the two yieldsballooned to 1.3 percentage points, has the spread been sogreat. Surpassing levels reached in October 1998 this week, thecurrent spread continues to grow as investors look for one morerate cut when the Fed meets on May 15 and prepare to confrontthe threat of faster inflation. ``The bond market knows the mess we're in now, but it's lookingout six months to a year,'' said Garth Nisbet, who oversees $1.7billion in stocks and bonds as chief investment officer at CrabbeHuson Group in Portland, Oregon. ``There's been a nice rally inthe two-year note as the Fed cuts rates, but lower rates are notgreat news for the long bond,'' because it sees them as sparkingfaster inflation, he said.
Little Compensation
The yield on the current 30-bond is just 1.95 percent, whenadjusted for the consumer-price inflation rate through February.While that's well below the 3.78 percent rate at the end of 1999,it's more than the 1.77 percent yield offered just two-and-a-halfweeks ago. Since March 14, the yield on the 30-year bond hassoared almost 19 basis points as investors priced in the effectsof a potential economic rebound. In 1996, the difference in yield between the two-year note and30-year bond hit its widest point on Feb. 19, at nearly 1.33percentage points. Leading up to that, the Fed had loweredinterest rates twice in 1995, and once in 1996, on Jan. 31. Afterthat, rates held steady at 5.25 percent, until the Fed raised themin March 1997, the first time they had done so in more than twoyears. This time could be similar, analysts said. ``If we do have an about-face, it would reflect a very changedenvironment for the bond market, as it would have to contendwith the strength of economic activity,'' Miller Tabak's Crescenzisaid.
Wider Still?
Of course, the difference between the two yields may growfurther still if the 30-year bond factors in even more inflation asthe Fed lowers rates, said Douglas Johnston, chief governmentbond strategist at Lehman Brothers Inc. If it does, yields willrise, pushing the spread to 1.5 percentage points or more, hesaid. ``It's very surprising that the market isn't pricing in more inflationas it looks for the Fed to cut rates, so, it's fair to say that thespread could widen and keep going until it just don't feel good,''he said.