Why the countdown to a recession is starting now, according to these bond market signals

Why the countdown to a recession is starting now, according to these bond market signals

The sirens of recession began to sound louder in the bond market in November, even with a buoyant US labor market that took away the likelihood of an economic slowdown for many households.

A closely watched chart of bond yields that compares TMUBMUSD03M 3-Month Treasury Bills,
and 10-year treasury bills TMUBMUSD10Y,
ratings has now “reversed” (see chart) for the first time this cycle, meaning investors can earn more on securities that mature in just a few months, rather than those that mature in a decade.

Another key element of the bond market is the flashing of recession warnings

TS Lombard, Bloomberg

In more normal times, investors are generally paid more for investing their money for longer periods. But the rapid pace of rate hikes by the Federal Reserve this year has unleashed a torrent of volatility in markets and clouded the near-term outlook for the economy.

As a result, bond investors have become reluctant to invest in the short term, given challenges from the Fed as it strives to rein in the economy, rein in inflation perched near a 40-year high and to avoid throwing the economy into the ditch.

These concerns became more evident in the $24 trillion Treasury market months ago, when the 2-year Treasury TMUBMUSD02Y,
the yield eclipsed the rate on bonds maturing in 10 years, triggering an earlier recession signal.

“But the 3m10y [inversion] is important because it has always been more accurate in predicting recessions,” wrote Skylar Montgomery Koning, senior macro strategist at TS Lombard, and Andrea Cicione, head of research, in a client note on Tuesday.

“The market and the consensus say in the next 12 months: the countdown to recession has begun.”

Recession signals are piling up

Additionally, the Fed’s preferred “forward spread,” a measure of the spread between the yield on 18-month forward, 3-month bills and the 3-month spot yield, nearly reversed (see chart). It is likely to swing above the line soon, leaving all important yield curve metrics in inverted territory, according to Deutsche Bank.

Major points on the Treasury market yield curve line up for reversals in 2022, sending strong signals of recession

Bloomberg, Deutsche Bank

“Essentially, this reflects where the market thinks policy rates will be in 18 [months versus] today, with a reversal indicating the market view that the Fed will have reduced in a year and a half,” the TS Lombard team wrote.

See: Recession in sight? This bond market indicator displays a “code orange” warning.

As part of its fight against inflation, the Fed launched its fourth consecutive jumbo rate hike of 75 basis points on Wednesday, taking its key rate to a range of 3.75% to 4%, the highest level in 15 years old.

“Nobody knows if there’s going to be a recession or not,” Fed Chairman Jerome Powell said Wednesday at an afternoon news conference. “Our job is to restore price stability.”

Powell said the path to a soft landing for the economy had narrowed over the past year, while also signaling that monetary policy could remain tight for longer than expected as the central bank strives bring inflation back to its target range of 2%.

He also said it was very “premature” to focus on a pause in the Fed’s tightening campaign, while declining to elaborate on the potential size of a rate hike in December.

It should be noted that 3-month/10-year yield curve inversions are an accurate predictor of past recessions since 1973, according to TS Lombard, which considers them to occur 12 months on average before past economic downturns over the past few years. last 50 years or so. .

Shares fell at Powell’s afternoon press conference, giving up earlier gains to end sharply lower. The Dow Jones Industrial Average DJIA,
slipped 505 points, ending down 1.6%, while the S&P 500 SPX index,
fell 1.5% and the Nasdaq Composite Index COMP,
paid 3.4%, according to FactSet.

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