Daily Management Review

'Powell's Curve' Drops To New Lows, Signaling An Impending US Recession


The favored bond market indicator of an impending recession used by the Federal Reserve has plummeted to new lows, supporting the argument that the central bank will soon need to lower interest rates in order to boost economic growth.
According to Fed research, the most consistent bond market indicator of an impending economic downturn is the "near-term forward spread," which compares the forward rate on Treasury bills for the next 18 months with the current yield on a three-month Treasury bill.
This week, this spread, which has been in the red since November, hit new lows, closing at around minus 170 basis points on Thursday.
The 18-month U.S. Treasury yield curve, according to Fed Chair Jerome Powell, is the most accurate indicator of an impending recession.
"Powell's curve ... continues to plunge to fresh century lows," Citi rates strategists William O'Donnell and Edward Acton said in a note on Thursday. Refinitiv data showed the curve was the most inverted since at least 2007.
Investors are concerned that the turmoil in the banking sector caused by Silicon Valley Bank's failure in March could tighten credit conditions and harm growth, which has led to an increase in recession fears in recent weeks.
To combat inflation, the Fed has started one of its most aggressive rate-hike cycles in decades, and it expects borrowing costs to stay at current levels through the end of 2023. However, market players are betting on rate reductions later this year because they feel tighter monetary policy is already beginning to damage GDP.
It's not difficult to understand why markets may be increasingly assuming "policy error" when reading about more rate hikes when considering that curve inversion in light of recent falls in economic indicators and money supply, according to Citi's analysts.
The Fed increased interest rates by a quarter of a percentage point last month to combat inflation, but it also signaled that it was about to pause future rises in borrowing costs due to the banking crisis.
The St. Louis Fed President James Bullard stated on Thursday that the Fed should continue raising interest rates to control inflation while the labor market is still robust. Recently, some Fed officials have urged for additional hikes.
On Thursday, money market speculators, however, were overwhelmingly wagering that the Fed will have dropped rates from the current 4.75%-5% range by approximately 70 basis points by December.
"All this tightening of financial conditions, with the Fed raising rates significantly, now it's morphing into maybe a little bit of a credit tightening," said Jack McIntyre, portfolio manager at Brandywine Global.
"Our conviction level down the road is that rates are going to be lower," he said.