Recent U.S. 2-year and 10-year Treasury yieldThe rapid narrowing of interest rate spreads has some investors worried regarding the warning signs of an impending recession, and Federal Reserve Chairman Powell disagreed, saying that the preferred indicator of central bankers is the 3-month and 18-month forward contracts The spread between interest rates and the indicator is currently not flashing recession warning signs.
In the spot market,10-year Treasury yieldStill higher than the 2-year period, but the gap narrowed to 0.22% from 1.62% a year ago. The rapid narrowing of interest rate spreads mainly reflects that the Fed’s tightening policy will slow down economic growth or even fall into recession.
2 years and 10-year Treasury yieldThe spread is an indicator widely concerned by the market, and the spread between the two has fallen into negative value in every economic recession since 1980. The spreads of other maturities of U.S. bonds, such as 7-year and 10-year bonds, have inverted.
Forward contract pricing shows bond traders now expect 2-year and 10-year Treasury yieldThe curve inverts in as soon as three months, a harbinger of a potential recession.
Traders expect 2-year yields to reach regarding 2.29 percent by June, up from 10-year Treasury yieldIt was up regarding 1 basis point, up from 0.4 basis point on Friday.
In response to market concerns, Powell said the Fed has another preferred recession indicator. “There is good research by my colleagues in the Fed, looking at the short end of the yield curve — the first 18 months,” he said in response to questions from the National Association for Business Economics (NABE) on Monday. Upside down, it means the Fed will cut rates, which means the U.S. economy is weak.”
The spread between the three-month Treasury bill yield and the level at which the forward market is betting on rates over the next 18 months is now around 229 basis points, according to data compiled by Bloomberg. The steep short-end move is in stark contrast to other indicators that suggest a recession is looming.
According to research published in June 2018, Fed economists Eric Engstrom and Steven Sharpe argued that the so-called “near-tem forward spread” is wider than the two-year and 10-year yieldA more accurate indicator of recession for the curve: A near-term negative turn in forward yield spreads usually means the market expects a rate cut within 18 months.
Forward spreads were at their highest since 2002 on Monday. Before the last three recessions, the indicator was upside-down. Negative spreads mean traders are expecting the Fed to cut rates, which in the past has only been done when the economy is on the verge of recession, so it also means the market is expecting a recession.
From the perspective of Eurodollar futures, traders currently expect the Fed to cut interest rates by the end of 2024.
Ball explained that while the Fed is still focusing on 2 years and 10-year Treasury yieldcurve, but prefer to focus on the short end of the yield curve, and that’s just one of many things the Fed is watching.