- Jerome Powell’s preferred gauge for bond-market pricing is in danger of inverting.
- This would signal a Fed pivot before the spring of 2024 and an impending recession.
- The Fed chair praised earlier this year the predictive power the short end yield curve.
Jerome Powell’s favorite bond-market gauge is on the verge of inverting, which would signal the US economy is barreling towards a recession — and that means the Federal Reserve could pivot to cutting interest rates in a matter of months.
The gap between the three-month Treasury bill yield and the expected yield in 18 months fell to 0.2% on Tuesday, as opposed to 2.7% in April. Bloomberg.
Inverted yield curves are those where the interest rates on short-term fixed income securities is higher than those for long-term securities. It is an indicator that investors are uncertain of the future and is considered a sign of a coming economic 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,” Powell March
“That’s what actually has 100% explanatory power in the yield curve. It makes sense. He said that if the Fed reverses it, then the Fed will cut. This would indicate that the economy is weak.”
The Fed chair stated that if the three-month yields of bonds today are higher than what investors expect them to become in 18 months, it means that the US central bank will cut interest rates. If the market believes rates will be cut within such a short period of time, then the economy is most likely to fall into recession.
Powell and his fellow economists raised interest rates from virtually nothing in March to a range ranging from 3% to 3.25 percent this year. Their goal is curbing inflation, which rose to a 40 year high of 9.1% last June and remained above 8.8% in September.
Investors are concerned that higher rates will reduce consumer spending and investment. They also fear that it will make US exports less competitive and strengthen the dollar. This could create the conditions for a severe recession. A Fed mega-hike of 75 base points is expected at Thursday’s October meeting. This could turn Powell’s favorit yield curve around.
Investors will be more concerned about a possible recession if that happens. The bright side is that investors might look forward to a Fed pivot before the spring of 2024. This is because rate hikes this year have had an adverse effect on the prices for stocks, bonds and other assets.
