Before the 3-month and 18-month U.S. Treasury yield curves were on the verge of inversion, at the end of October, another closely watched recession warning indicator, the 3-month and 10-year U.S. Treasury yield curves, appeared in 2020. for the first time in months.
The market is widely expected that the Federal Reserve is likely to announce after the meeting on Wednesday, raising interest rates by 75 basis points for the fifth consecutive time. On the eve of the announcement of the decision to continue aggressive interest rate hikes, an indicator closely watched by Fed Chairman Powell and other Fed officials is close to triggering an alarm for a recession.
On Tuesday, November 1, Eastern Time, the spread between the 3-month and 18-month U.S. Treasury bonds once narrowed to less than 0.2 percentage points, on the verge of an inverted yield curve, far lower than the 2.7 percentage points in April this year. .
The so-called inverted yield curve refers to the fact that the yields of relatively long-term U.S. Treasury bonds are lower than the yields of shorter-term U.S. Treasuries. The inversion is often seen by investors as an early warning sign of an impending recession, as markets begin to price in an end to monetary tightening and accept the prospect that the Federal Reserve will lower interest rates in the future to soften the blow of the economic downturn.
Prior to this, the yield curve of several closely watched U.S. Treasury interest rate portfolios had inverted, including the 2-year and benchmark 10-year U.S. Treasury yield curves, which are often regarded as recession indicators. And the 3-month and 18-month Treasury yield curves are important in part because of Powell’s favor.
In his public statement in March this year, Powell tried to downplay the outside world‘s emphasis on the inversion of 2-year and 10-year U.S. Treasury yields. When he answered questions at the event that month, he said,
The staff of the Federal Reserve has done a lot of research on observing short-term U.S. Treasuries and the yield curve of the first 18 months. It does explain 100% of the power of the yield curve. This makes sense. Because if it goes upside down, it means the Fed is going to cut rates, which means, the economy is weak.
Wall Street News previously mentioned that before the Fed announced interest rate hikes in July this year, Powell emphasized that the 3-month and 18-month Treasury bond yield curves, which are indicators of economic recession, are sending a warning signal, and expectations for sharp interest rate hikes are weakening.
Coincidentally, not long ago, at the end of October, the 3-month and 10-year U.S. Treasury yield curves inverted for the first time since March 2020. At the time, the analysis pointed out that the New York Fed had previously said that the combination of 10-year and 3-month Treasury bond rates has been very successful in predicting recessions in recent decades, and given the recession forecasting ability of this combination, its inversion may contribute to the Fed slightly. The idea of pausing the current rate hike process.
Frances Cheung, interest rate strategist at Oversea-Chinese Banking Corp. in Singapore, commented this week that the Fed’s policy rate is entering levels that constrain the economy, amid some weak economic data recently. At a certain point, the Fed will need to reduce the magnitude of rate hikes, which could happen right at the December Fed meeting.
The Chicago Mercantile Exchange’s (CME) “Fed Watch Tool” shows that at midday Tuesday, the U.S. federal funds rate futures market expects the Fed to raise interest rates by 75 basis points in November. The probability of raising interest rates by 75 basis points is close to 88%. The 75-basis-point chance is a little over 50%, and the December 50-basis-point chance of a rate hike is more than 44%.
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