Bond markets are flashing a recession signal that suggests the Fed may be about to step in to quickly cut rates

MARCH 29, 2023

Traders work on the floor of the New York Stock Exchange Monday, Dec. 8, 2008. AP/Richard Drew

Bond markets are flashing a major recession signal, and it suggests an incoming downturn may be steep enough for the Federal Reserve to step in and quickly cut interest rates, according to DataTrek.

In a note on Wednesday, the research firm pointed to the recent surge in yields on short-term Treasuries, with the iShares 1-3 Year Treasury exchange traded fund moving up 2 standard deviations in recent days. There have only been three cases when short-term Treasuries had jumped by that amount, the firm said:

In all of these cases, the Fed moved quickly to cut interest rates – which suggests the signal’s reappearance could be an omen for markets.

“The default scenario baked into asset prices is based on the Fed pivoting – quickly – to lowering policy rates. That can only mean a recession is close at hand, one that would reduce inflation and be steep/deep enough to force the Fed to act,” DataTrek’s co-founder Nicholas Colas said.

Central bankers have raised interest rates aggressively over the past year to lower inflation, with the fed funds target rate at 4.75-5%, the highest rates have been since 2007.

But since inflation is still well-above the 2% target, the Fed would only pull back on interest rates if the economy slips into a downturn, Colas previously has said, adding that he didn’t see the US going through the next 12 months without a recession.

His outlook echoes that of other grim prognosticators, with legendary investors like Jeffrey Gundlach and Jeremy Grantham warning a downturn is imminent. I

n particular, experts say the risk of recession has increased with the recent collapse of Silicon Valley Bank, as banks’ reluctance to lend slows the economy.

Courtesy/Source: Market Insider