Traders work on the floor of the New York Stock Exchange.
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Although it seemed that the fear of last year’s recession was a false alarm, the bond market is about to send another signal of slowdown.
The yield curve, or the spread between bonds of various maturities, narrows again, the spread between three-month and ten-year treasury bills being less than 5 basis points on Wednesday.
When the three-month rate exceeds the 10-year benchmark yield, this is called an inverted yield curve and has been a strong sign since 1950 that a recession will occur in the next 12 months.
The curve reversed in May and then returned in October, apparently dispelling concerns that the longest expansion in U.S. history was coming to an end. The curve briefly reversed Tuesday morning.
The New York Fed tracks the relationship and establishes a probability based on the spread. At the end of 2019, the chances of recession stood at 23.6%, still high, but far from reading nearly 40% as the curve reversed.
Fed officials, who conclude their two-day political meeting on Wednesday, may again face the prospect of an economic slowdown if the bond market is right about the outlook ahead.
“While the Fed may want to present its 2020 rate policy as stable, the markets are signaling that their bias should be to continue easing,” said Nicholas Colas, co-founder of DataTrek Research, in his daily note Wednesday.
The Fed was not expected to move rates this week. President Jerome Powell said it would take a “material reassessment” of current conditions to cause the central bank to relax further after the 2019 “mid-cycle adjustment” which saw three cuts.
Another concern for the Fed is the widening spreads of speculative-grade corporate debt relative to government bonds of the same duration, said Colas. In addition, stocks have rallied as the Fed has increased its balance sheet since October, putting increased pressure on policy makers to remain accommodative.
“As Coronavirus Gained Market Attention Over The Past Week, Fed Policy Will Return To The Front [Wednesday] and it will be a difficult transition, “said Colas.” There is not much the Federal Reserve can say; they are in the same boat as the investors when it comes to assessing what will happen next. “