What the bond market is saying about the Fed

If there's any doubt the Fed is targeting December for its first rate hike, just look at the bond market.

The 2-year yield touched 0.91 percent early Friday, as investors reacted to the words of Fed Vice Chairman Stanley Fischer. The yield was just under 0.90 in afternoon trading, and analysts say it is in a range that could be stretched in the next few weeks if the Fed's path to rate hikes remains on track. The 2-year last traded at that level more five years ago.

"The bond market is saying the Fed's going to raise rates, make no mistake about it," said David Ader, chief Treasury strategist at CRT Capital. Ader said his target for the 2-year is 0.95 percent.

"If we're going to see 95 basis points, we're going to be seeing it at 8:35 a week from Friday, not necessarily in advance," he said, referring to the release of the November employment report. "As much as you might think the Fed's going, let's let the ECB do its thing and that could have a bullish impact. There's just not that much mission critical."

Read More Fed to markets: Rate hike is coming your way

The European Central Bank meets the day before the Dec. 4 jobs report, and it is widely expected to expand its quantitative easing program and possibly cut its discount rate. That could send low bund yields even lower and weigh on the euro. The German 2-year is currently trading with a negative 0.38 percent yield.

"We've really blown out in terms of our 2-year underperforming. We are dirt cheap to the rest of the world — more in 2s than further out the curve. All of a sudden it looks damn attractive," said Ader.

That should also keep some pressure on yields, as global investors seek out relative value in U.S. bonds. The German 2-year is currently trading with a negative 0.38 percent yield. Yields move inversely to bond prices.

Read More Expect at LEAST three rate hikes in 2016: Economist

The market is also anticipating Monday's $26 billion 2-year note auction. "You think there's going to be a concession," said Ader. "How these auctions are going to play out are very dicey in trying to get a read on it."

Lindsey Group strategist Peter Boockvar said the 2-year yield should stay around current levels for now, or edge higher. "I think if the Fed's raising rates, it's going to remain stuck here. There's no need for it to go down if the Fed's raising rates, and it's almost a guarantee the Fed raises unless something dramatic is going on," he said.

The minutes from the Fed's last meeting this week reinforced the October statement, steering markets toward the idea the central bank will hike rates barring some unforeseeable reversal. Then Fischer spoke late Thursday, and again drove the message that the Fed wants to raise rates at its next meeting, Dec. 15-16.

"They went out of their way — to the point of Fischer saying nobody should be surprised if they move. We're not surprised. We wouldn't have been surprised in September. What we're surprised about is they're still talking about it," said Arthur Bass, managing director at COEX Partners.

Read More Fed's Vice Chair Fischer signals rate hike

As the policy sensitive two-year (U.S.:US2Y) yield rises, the 10-year yield has gone up more slowly. "If the Fed is in play and the Fed's tightening, you're going to see a flattening of the curve," said Bass.

The 10-year yield was at 2.25 percent Friday, and analysts say the Fed would like to see that yield stay relatively low since it is the one tied to mortgages and other consumer loans.

The 2s to 10s spread at the end of Thursday's trading narrowed to the lowest closing gap since April at 136 basis points, said Boockvar. It was at 141 basis points before the release of the minutes Wednesday and had widened to 151 on Sept. 17, the day the Fed surprised markets by choosing not to raise rates.

"if you go back five years, the average was more like 180 basis points," he said. "The Treasury market is just in the early innings of responding to the likelihood of a Fed rate hike. The market is a little skeptical of the economy's ability to handle a rise in short term interest rates."

Read More Fed's Dudley: There's still time to decide for December

While the market is moving with the Fed toward a December hike, there are expectations the Fed will move slowly toward the next series of rate hikes. The fed funds futures are pricing in a 73 percent chance of a December hike, but they're only pricing in two hikes for next year.

"That's the whole game. We've taken forever to get to December (liftoff). We've finally gotten that. Barring something unforeseen, they're going," said Bass. "It all gets down to what's the next path forward."

Ader said the Fed just needs to see 140,000 new jobs in the November report, and that could be a catalyst for yields to rise if investors believe the employment data supports a Fed hike.

In its minutes, the Fed said, "Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market and inflation, these conditions could well be met by the time of the next meeting."

But it also said the actual decision would depend on the implications in the economic data released between the October and December meetings. The Fed minutes noted that improvement in the labor market had slowed somewhat in recent months, but that was before the robust October jobs report showed 271,000 new nonfarm payrolls.

Read More Most FOMC members see December rate hike as appropriate

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