Jason Katz, Managing Director and Senior Portfolio Manager at UBS, shares his outlook for the Fed and markets.
One of Wall Street’s most popular indicators of an impending recession is flashing red, raising fresh fears that the US economy is headed for a downturn this year.
The spread between 5-year and 30-year Treasury yields briefly reversed on Monday for the first time since 2006 amid fears that the Federal Reserve’s aggressive approach to tackling the hottest inflation in four decades could result in a sustained slowdown in growth could lead.
Fed hikes interest rates for first time in 3 years and projects 6 more rate hikes as inflation surges
Yields on 5-year Treasury bills rose as much as 2.63% on Monday, outperforming 30-year bond yields (which fell to about 2.60%). The spread between 5 and 10 year government bonds reversed earlier this month.
Federal Reserve Chairman Jerome Powell during a hearing of the Senate Committee on Banking, Housing and Urban Affairs September 28, 2021 in Washington. (Kevin Dietsch/Getty Images/Bloomberg via Getty Images/Getty Images)
Yield curve inversions, which rarely occur, are considered a good recession indicator as they suggest investors believe economic growth is slowing as long-term bond yields are lower than short-term bonds.
“Markets are fixated on the US Treasury yield curve as it is seen as an excellent measure of the economy,” said Anu Gaggar, global investment strategist for Commonwealth Financial Network. “If the economy is healthy and growing, longer-term Treasury rates should be higher than shorter-term rates. If the opposite occurs, concerns about the future economic situation will increase.”
The more closely watched spread between 2-year and 10-year bond yields is also narrowing, falling from a peak of 1.56% to less than 0.2% in just a year. This is the flattest spread in two years, before the pandemic took hold and triggered an extremely deep but brief recession.
Every recession over the past 60 years has been preceded by an inverted yield curve, according to a study by the Federal Reserve Bank of San Francisco.
The bond market move comes as the Fed takes a more hawkish approach to fighting inflation: policymakers hiked rates by a quarter of a point two weeks ago and have since signaled support for a faster half-point hike at their May meeting.
A man walks past the Federal Reserve building in Washington on April 29, 2020. (Xinhua/Liu Jie via Getty Images/Getty Images)
“If we decide it’s appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at one or more meetings, we will do so,” Chairman Jerome Powell said during an economics conference last week . “And if we find that we need to move beyond the usual measures of neutrality to a more restrictive stance, we will do so.”
The Labor Department reported earlier this month that the consumer price index rose 7.9% year-on-year in February, the fastest rise since January 1982, when inflation hit 8.4%. The CPI – which measures a variety of commodities ranging from gasoline to health care – rose 0.8% from January.
Some economists believe the Fed has waited too long to stem the surge in inflation, while others have expressed concerns that acting too quickly to stabilize prices could trigger the risk of an economic recession. Rising interest rates tend to result in higher interest rates on consumer and business loans, which slows the economy by forcing employers to cut spending.
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Still, Powell has quashed concerns that an inverted yield curve is signaling that the economy is headed for a recession, maintaining optimism that the Fed can strike a delicate balance between taming inflation without weakening the economy.
“The likelihood of a recession next year is not particularly high,” Powell told reporters two weeks ago, citing the strong labor market, solid wage growth and strong corporate and household balance sheets. “All signs point to this being a strong economy that can thrive in the face of less accommodative monetary policy.”