Key Recession Indicator Sends Sharp Warning

Myles Udland |

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The Treasury market is sending its sharpest warning about recession risks since 1981. This week, the difference in the yield on 2-year and 10-year Treasury notes further inverted, with the yield on the 10-year falling 103 basis points, or 1.03 percentage points, below the yield on the 2-year yield. This dynamic has preceded each of the last eight U.S. recessions. By this measure, the yield curve has been inverted since July of last year as investors bet aggressive interest rate hikes from the Federal Reserve to combat inflation would tip the economy into recession. In an appearance before the Senate Banking Committee, Fed Chair Jerome Powell signaled the central bank will likely be more aggressive than it previously forecast in raising interest rates this year as inflation proves stubborn and the labor market remains strong. "The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated," Powell told the Senate Banking Committee in prepared remarks. "If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes." The Fed will announce its next policy decision on March 22. Investors are now pricing in 100 basis points of additional rate hikes from the Fed this year, up from the 75 basis points previously expected by most economists. Markets are now pricing in a nearly 80% chance the Fed raises rates by 50 basis points, or 0.50%, at its meeting later this month. With the 2-year treasury note currently yielding around 5%, this implies investors think the fed funds rate will be, on average, 5% over the next two years. Today, the fed funds rate stands at roughly 4.6%, as the Fed's target interest rate range is 4.5%-4.75% following its decision last month to raise rates an additional 25 basis points.