"Recession Coming," Treasurys Tell Investors
Market Provides the Direction that Fed officials Do Not
Senior officials of the Federal Reserve continued making conflicting statements last week on where the Federal Funds rate should be headed and, in the process, added to overall confusion and market volatility. Speaking at the start of the week, Vice Chair Lael Brainard suggested at a Bloomberg fireside chart that “it will probably be appropriate soon to move to a slower pace of increases.”
Brainard’s statement was probably influenced by the deceleration in consumer price inflation indicated in data released the previous week, and it anticipated the relatively benign Producer Price Index number that followed on Tuesday. The headline PPI rose 0.2% month-on-month in October, well below consensus expectations. The core PPI (which excludes food and energy) was flat from September to October, compared with the consensus expectation of a 0.3% increase.
In contrast to Brainard, Jim Bullard, President of the St. Louis Fed and a voting member on the Federal Open Markets Committee, said Thursday that the Federal Funds rate may have to rise to between 5% and 7% from the current range of 3.75 - 4%. The ceiling range he suggested is much higher than consensus. Bullard based his forecast on the application of the Taylor Rule for monetary policy developed by Stanford University Professor John Taylor.
While it is positive that Bullard would opt for a rules-based interest rate policy, Federal Reserve Chairman Jerome Powell has given no indication of the existence of such discipline within the central bank. There has so far been no structured process to decide whether (or why) a rate increase should be 50 or 75 basis points, for example.
Contradicting Brainard even more directly, Susan Collins, President of the Boston Fed, said Friday that “75 [bp] still is on the table, I think it’s important to say that as well.” Collins, who will vote at the FOMC meeting on December 14, said she believes that it is still possible to lower inflation without significantly increasing the unemployment rate. That sentiment also implied her support for continued monetary tightening, something that is anathema to financial market investors.
How are investors to make sense of these opposing views by senior central bank officials who determine monetary policy for the world’s largest economy? It does not pay to rely on the guidance of any single individual, not even that of Chairman Powell. Recall that the FOMC increased rates by 75bp in June for the first time since November 1994 despite forward “guidance” from Powell that it was likely to be a 50bp hike. After implementing the increase on June 15, the Chairman said at a press conference, “Today’s 75 basis-point increase is an unusually large one and I do not expect moves of this size to be common.” Three more 75bp hikes followed at successive FOMC meetings.
Instead of following Fed officials’ “guidance,” it pays to look at what the Treasury market is telling us. The spread between the yields on two- and 10-year Treasurys widened to -70bp last night, the largest negative spread that the curve has experienced since the early 1980s. Not even prior to the 2008 financial crisis was the 2-10 curve so inverted. As I explained last April, for a variety of reasons, a large and prolonged inversion has been a reliable predictor of recession to follow several months later. The current bout of widening spread between the two yields began in early July.
This time, another portion of the Treasury curve has also come in with a recession signal. The spread between three-month and 10-year Treasury obligations, which started to go negative only in late October, ended last week at -52bp. The figure is approaching the peak inversion for this portion of the curve ahead of the global financial crisis of -64bp on February 27, 2007. The Great Recession began in December that year.
These signals are neither calming nor reassuring for investors and members of the labor force. However, they have historically been more reliable indicators compared with the divergent and shaky forecasts by Fed officials that markets have had to deal with.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
November 19, 2022
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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i found mr Bullard presentation almost entertaining and i am saying this respectfully. A very comprehensive lecture on the Taylor rule and what it was and is signalling in terms of policy actions. then you go back to slide 6 of his deck and you wonder "what were you guys doing for at least 8 months when inflation clearly took off and you didn't do anything?" you are right: do we have a rule based FED or a totally discretionary FED? they will never tell us...Lastly, i wonder how QT is factored in the Fed's decision making because if QE was contributing to lower rates then QT should have at least a symmetrical impact...