The Federal Reserve’s fifth-straight outsized rate hike may spur fresh warnings that a recession is inevitable, based on a bond-market signal preferred by Chair Jerome Powell himself.
Powell’s favoured yield curve — where three-month rates are now versus where they are expected to be in 18 months’ time — is on the cusp of inverting, with the spread between the two tumbling to a mere 0.2% Tuesday from 2.7% in April. An inverted yield curve is a key warning sign for many investors that a recession is coming and many closely-watched spreads in the Treasury market have already flipped below zero.
“Policy rates are entering restrictive levels while there have been some soft patches of economic data of late,” said Frances Cheung, a Singapore-based rates strategist at Oversea-Chinese Banking Corp. “At some point, the Fed needs to move to smaller rate hikes, and this may happen at the December FOMC meeting.”
In March, Powell downplayed the significance of two-year yields rising above 10-year rates — an often-cited harbinger of recession. He argued traders were looking at the wrong metric and that the shorter-end measure gives a clearer read because “if it’s inverted, that means the Fed’s going to cut, which means the economy is weak.”
Global markets have been roiled this year by an increasingly-hawkish Fed arguing that it needs to quash sky-high inflation even at the risk of a so-called hard landing for the economy. Its conundrum looks to be intensifying as robust inflation and labor-market data contrast with signs of weakness in other parts of the US economy.
Another widely-followed yield curve — the gap between 3-month and 10-year Treasuries — inverted last week for the first time since March 2020.
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