(Bloomberg)-Jerome Powell responded briefly this week to apocalypse pointing out horrific Treasury market movements as evidence that the Federal Reserve is turning into recession through its tightening campaign.
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Instead of sticking to the ominous bond shift (like 5-year rate trading above 10-year and flatter US curves), more generally, Wall Street traders get clues from another corner of the debt world. You need to get. Short-term yield curve.
On Monday, Powell said a sharp gap between the positive interest rates on three-month Treasury securities and current three-month levels as a clear sign that the bond market actually fully revealed the economy. Was quoted.
Powell’s message at the National Business and Economic Association was unmistakable. The Fed has plenty of room to aggressively raise interest rates to combat inflation without hindering growth.
The Treasury was hit further on Friday, with Citigroup Inc. raising expectations of rate hikes, including four consecutive half-point moves.
As a result, there are increasing warnings of policy mistakes that trigger a recession. This week, Goldman Sachs Group Inc. has joined the ranks of those who predict a “moderate reversal” with a two- to ten-year spread by the end of this year. A reversal of short-term yields over long-term yields is a long-standing, widespread indicator of growth problems to date.
“It’s becoming increasingly clear that the FRB is risking growth to combat inflation,” said Peter Yi, short-term fixed income director and credit research director at Northern Trust Asset Management. Said. “Powell has suggested that all meetings are live and that every meeting can be raised by 50 basis points, which creates pressure to reverse the curve.”
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Short-term forward spreads measure the difference between a 3-month rate after 18 months and a bet of the same rate today. The curve soared to its highest level in years, with the more traditional 3-month and 10-year spreads. This is because the hawkish Fed has accelerated interest rate hikes and was inspired by expectations that the federal funds rate will rise to around 2.8%. The end of 2023.
The 2018 Fed’s research paper emphasized that the short-term yield curve eliminates complex factors such as the so-called term premium and thus more clearly reads market expectations for future monetary policy. In fact, the gauge will only reverse if a large cohort of investors expects a rate cut based on slowing growth. A previous Fed study found that it had better predictability than the rest of the curve-a conclusion approved by the Chair on Monday.
Bank of America Corporation economist Aditya Barb said in a Friday note: “As we discussed earlier, the two-year and ten-year reversal is that the market is pricing a significant rate cut by the FRB. It was a credible sign of a recession because it showed. ” “Today, the slope of the yield curve is constrained by the negative term premiums and ultra-low yields of other countries, which makes long-term government bonds very attractive to foreign investors.”
History shows that it foresaw a pending recession as consumer spending and business activity increasingly buckle under the weight of policy tightening as the power of the federal tightening cycle causes a reversal of the yield curve.
Campbell Harvey was one of the first to historically link in his study of three-month, ten-year spreads, which reversed before the last eight US recessions. Recently, a professor at Duke University’s Fuqua School of Business is concerned about the growing threat to the US recovery, even though his beloved spread hasn’t flashed “code red” yet.
Harvey said high inflation and “all geopolitical risks that have yet to feel economic success other than gasoline pumps behave like taxes.” “It all shows a slowdown in economic growth.”
Read more: History shows that the Fed is unlikely to offer a soft landing
For similar reasons, money managers, including Northern Trust Yee and Pinebridge Investments LP Stephen O, believe the Fed is likely to suspend policy tightening later this year.
If the Fed decides to tighten in earnest, it seems inevitable that the main sections of the curve will be further flattened. The next leg is probably backed by a high three-month financial rate. The latter has plenty of room to catch up with the policy-sensitive two-year rate, which has already surged above 2% from less than 0.75% at the end of December.
Federal Reserve Bank of St. Louis Governor James Bullard, considered the most hawkish Federal Reserve policymaker, called for a policy rate increase of more than 3% this year due to the 1994 tightening cycle. I am. At that time, Federal Reserve Chairman Alan Greenspan surprised the market with his aggressive policy response. This closed the three-month and ten-year yield gap, but as the US continued to expand, it eventually stopped reversing its trajectory.
Read more: Bullard says “faster is better” for the federal government in a rate hike strategy
All this suggests that bond investors are at increased risk, with spreads between 5-year and 30-year securities narrowing again this week to levels not seen before the global financial crisis.
“Since the beginning of the year, the chances of a recession in 2023 have been nearly zero, but now it’s probably 25% to 35%,” said Oh, Global Head of Credit and Bonds at PineBridge. Says. assets.
(Added comments from Bank of America economists to the 10th paragraph)
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