- The bond market is flashing a recession signal that suggests the Fed will quickly cut rates.
- That's due to the large jump in short-term Treasuries, which the Fed has previously responded to by cutting rates.
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:
- March 2020, at the wake of the pandemic-induced recession.
- August 2007 and September 2008, in the midst of the Great Financial Crisis.
- October 2002, in the last month of the bear market amid the dot-com bubble bust.
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.