NEW YORK, April 6 (Portal) – The Federal Reserve’s preferred bond market signal of an impending recession has fallen to new lows, strengthening the case for those who believe the central bank must cut rates soon to revive economic activity.
Fed research has argued that the “short-term forward spread,” which compares the forward Treasury bill rate 18 months from now to the current yield on a three-month Treasury bill, was the bond market’s most reliable signal of an imminent economic contraction.
That spread, which has been in negative territory since November, plunged to new lows this week, trading at nearly minus 170 basis points on Thursday.
Fed Chair Jerome Powell said last year that the 18-month Treasury yield curve was the most reliable warning of an imminent recession.
“The Powell curve…continues to drop to new century lows,” Citi-rate strategists William O’Donnell and Edward Acton said in a statement Thursday. Refinitiv data showed the curve had been the most inverted since at least 2007.
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Recession fears have risen sharply in recent weeks as investors fear the turmoil in the banking system triggered by the collapse of Silicon Valley Bank in March will tighten credit conditions and hurt growth.
The Fed last year embarked on one of its most aggressive rate-hiking cycles in decades to fight inflation and forecast borrowing costs to remain at current levels through the end of 2023. However, market participants believe that tighter monetary policy is already starting to hurt growth and are banking on rate cuts later this year.
Viewing this curve inversion given the recent declines in economic indicators and the money supply, “it’s not hard to see why markets are increasingly thinking of a ‘political error’ when they read about further rate hikes,” said analysts at Citi.
The Fed continued its anti-inflation campaign, raising interest rates by a quarter of a percentage point last month, although it said it was on the verge of halting further increases in borrowing costs following the banking turmoil.
Some Fed officials have recently called for more rate hikes, with St. Louis Fed President James Bullard saying on Thursday that the Fed should stick with raising interest rates to bring down inflation as long as the job market remains strong.
Money market investors, however, largely bet on Thursday that the Fed would have cut rates by about 70 basis points by December from the current 4.75% to 5% range.
“All this tightening in financial conditions, with the Fed raising rates significantly, may now be turning into a small credit crunch,” said Jack McIntyre, portfolio manager at Brandywine Global.
“We are convinced that interest rates will be lower going forward,” he said.
Reporting by Davide Barbuscia; Adaptation by Ira Iosebashvili, Chizu Nomiyama and David Gregorio
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David Barbuscia