One of the bond market’s most popular indicators of the approaching US recession has the potential to post one of its most negative readings since the late 1980s reign of former Fed Chairman Paul Volcker.
This is the view of a team from BNP Paribas, which says that the spread between 2- TMUBMUSD02Y,
and 10 year treasury gives TMUBMUSD10Y,
That could gain about 130 basis points if the Fed ends its rate-hike cycle with a 4.75% fed-funds rate target. If the yield on a 2-year note exceeds the 10-year yield, the spread is negative or inverse.
He added that if the terminal fed-funds rate is above 5%, the spread could extend beyond minus 150 basis points. This is compared to Tuesday’s level of minus 35 basis points.
According to BNP economist Carl Ricadona, plus strategist Calvin Tse, the Fed’s commitment to holding rates in restrictive territory in the event of a recession makes the scenario of extreme reversals “plausible” based on analysis of spreads since the 1970s “plausible”. Is. Timothy High. The 2s10s spread – which has a reliable track record of predicting economic downturns, albeit with a lag – first turned negative in April of this year, before dropping below zero in the summer.
“Can the curve be inverted further? We think yes,” the BNP team wrote in a note. “A deep reversal was seen when the Fed was last fighting extremely high inflation. In fact, the most inverted curve in the last 50 years was in March 1980 at −241bp.”
Financial market participants are increasingly considering that persistent inflation could create an era of high rates around the world. Under Volcker, the Fed raised interest rates as high as 20% To break the back of inflation.
“To be clear, we are not necessarily forecasting another 75-100bp of 2s10s reversal,” the BNP team wrote. “Other factors such as domestic fiscal impulses, global consolidation, foreign bond yields rising from extremely disappointing levels, and Fed QT [quantitative tightening] 2s10s may contribute to the leveling of the UST curve.” Nevertheless, “in addition to the quantitative arguments, we believe there are fundamental ones that suggest that a much deeper curve inversion is possible in this cycle.”
One is that short-end yields will have a challenging time falling in the near term, noting that the Fed is likely to “move sharply toward housing amid early signs of labor worsening or an outright recession.” Meanwhile, “the long-term yield may instead serve as a ‘release valve’ to the price of an economic downturn (or potential recession).”
On Tuesday, traders and investors continued to likely adjust longer US interest rates, sending the 10-year yield towards 4%, a level not seen on an intraday basis since April 5, 2010. According to 10-Year Tradeweb, the rate has not finished at 4% or more during the New York session since October 15, 2008.
Shares’ initial rally in the afternoon faded, with the Dow Jones Industrial Average DJIA
down 90 points, or 0.3%, while the S&P 500 SPX,
Own 0.2% gain. The Dow slipped into a bear market on Monday, joining the S&P 500.
Credit: www.marketwatch.com /