Washington: A recession is certain and so are rate cuts this year. That’s the message from the bond market metric Federal Reserve Chairman Jerome Powell highlighted a year ago as the best guide to tip-off economic troubles in the US.
The expected three-month T-bill rate dropped to 134 basis points under the current rate. That’s below the previous record nadir it hit in January 2001 “- about two months before the US economy fell into recession.
“Frankly, there’s good research by staff in the Federal Reserve system that really says to look at the short - the first 18 months - of the yield curve. That’s really what has 100 per cent of the explanatory power of the yield curve. It make sense. Because if it’s inverted, that means the Fed’s going to cut, which means the economy is weak,” said Fed Chair Powell on March 21, 2022
Treasuries extended rally Thursday after the Fed raised its benchmark rate by a quarter point as traders ramped up bets the central bank will soon reverse course and start cutting interest rates. They are certain the Fed will lower rates in September to at least undo this week’s increase.
The market view contrasts with the Fed’s guidance that they expect to raise rates at least once from here, and with Powell’s comments that he doesn’t expect any reductions to borrowing costs this year.
“Given the tightening of policy thus far and the bank credit crunch, the odds are that the Fed will have to cut rates more quickly than the market currently anticipates,” TD Securities strategists including Jan Groen wrote in a note Wednesday. “As we continue to expect the economy to slide into a recession in 4Q, we maintain our call that rate cuts will commence at the December meeting.”
The two-year US yield dropped seven basis points to 3.87 per cent Thursday after Wednesday’s 23 basis points decline. The drop in two-year yields outpaced the fall in 10-year yields, resteepening the deeply-inverted part of the curve that many observers focus on as a recession indicator. That section of the curve has often climbed back above zero just before the onset of a contraction in the economy.
Swaps traders see about a 50 per cent chance that the Fed won’t raise rates again, after it hiked by 4.75 percentage points starting with the March 16, 2022, decision to raise by a quarter of a point.