US Federal Reserve chair Jerome Powell

(March 23): A recession is certain and so are rate cuts this year. That’s the message from the bond market metric Federal Reserve Chairman Jerome Powell highlighted a year ago as the best guide to tip-off economic troubles in the US.

The expected three-month T-bill rate in 18 months’ time dropped to 134 basis points under the current rate. That’s below the previous record nadir it hit in January 2001 — about two months before the US economy fell into 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. That’s really what has 100% of the explanatory power of the yield curve. It make sense. Because if it’s inverted, that means the Fed’s going to cut, which means the economy is weak.” — Fed chair Powell on March 21, 2022.

Treasuries rallied Wednesday (March 22) after the Fed raised its benchmark rate by a quarter point as traders ramped up bets the central bank will soon reverse course and start cutting interest rates. They are certain the Fed will lower rates by July to at least undo this week’s increase, according to swaps tied to policy-meeting dates.

The market view contrasts with the Fed’s guidance that it expects to raise rates at least once from here, and with Powell’s comments that he doesn’t expect any reductions to borrowing costs this year.

“Given the tightening of policy thus far and the bank credit crunch, the odds are that the Fed will have to cut rates more quickly than the market currently anticipates,” TD Securities strategists including Jan Groen wrote in a note Wednesday. “As we continue to expect the economy to slide into a recession in 4Q, we maintain our call that rate cuts will commence at the December meeting.”

Curve steepens

The two-year US yield was 2 basis points higher at 3.96% Thursday, having earlier extended Wednesday’s 23 basis points decline to 3.86%. However the move was outpaced by its 10-year peer, resteepening the deeply-inverted part of the curve that many observers focus on as a recession indicator. That section of the curve has often climbed back above zero just before the onset of a contraction in the economy.

Swaps traders see about a 50% chance that the Fed won’t raise rates again, after it hiked by 4.75 percentage points starting with the March 16, 2022, decision to raise by a quarter of a point.