Long Term Perspective
The spread between the 5-year Treasury note and the federal funds rate averaged -189 basis points in the 1980s. This was a period of high interest rates and (relatively) high inflation. The spread became positive in the 1990s, averaging 116 basis points.

The spread between the 5-year note yield and the federal funds rate averaged 124 basis points between 2000 and 2005. The average spread stood at 208 basis points in 2004, but fell to 83 basis points in 2005.

Short Term Perspective
It isn't unusual to see average yields on 5-year notes to run at least 100 basis points over the fed funds rate target. 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 and 2005 were anticipated by market players and did not come as a surprise at any point in time.

Average yields on 5-year notes decreased 22 basis points in August to 4.82 percent. Investors are no longer sure what to expect from the Fed: some are looking for a rate hike in the autumn, but others are already worried about a potential recession. It is way too early to expect a recession but many indicators are moderating.