Bonds: What the inversion of the yield curve reveals – 2024-08-07 04:45:58

A sharp increase in bets on a rate cut in the United States could further fuel a rally in bonds, fueled by weakening economic data. The latest data showed that the Federal Reserve will need to move faster in easing its monetary policy in order to prevent the US economy from falling into recession.

The past week has been marked by sharp swings in investor sentiment: the Fed’s decision last Wednesday to leave interest rates unchanged but open the window for a cut in September sparked a market rally and investor euphoria, which however proved extremely short-lived: just a day later, the unemployment benefits data rattled markets, which were hit on Friday with disappointing US unemployment, prompting a massive sell-off that extended on both sides of the Atlantic.

This has resulted in markets now discounting more aggressive interest rate cuts, and the first criticisms that the Fed has again been slow to react have already begun to be heard.

“The rising unemployment rate says the Fed has lost its bearings,” said Tony Farren, managing director of Mischler Financial Group.

Bets on bonds

As Reuters points out, investors in futures contracts tied to the Fed’s overnight policy rate now see the Federal Reserve cutting rates by about 120 basis points this year, nearly double what they had predicted before Wednesday’s meeting . Bond yields, which move inversely to prices, fell sharply with two-year yields hitting their lowest since March last year and benchmark 10-year yields at their lowest since December.

The latter elements triggered the Sahm rule

The 2/10 yield curve, which has been inverting continuously for more than two years, was at minus 9 basis points, – the closest to a positive turn since the inversion began. In the last four recessions, this curve had turned positive a few months before the economy began to contract.

The Sahm rule

Data on Friday showed the jobless rate rose to 4.3%, signaling an unexpected deterioration in a labor market that has so far shown surprising resilience during the Fed’s aggressive rate hike campaign. And analysts say the two-tenths of a percentage point increase in the unemployment rate triggered the so-called Sahm Rule, a historically accurate early indicator of recession.

The rule, which aims to signal the onset of a recession more quickly than the current process that officially dates business cycles, identifies signals associated with the onset of a recession when the three-month moving average of the national unemployment rate rises by 0.50 percentage point or more from its low in the previous 12 months. On Friday, this index increased to 0.53 percentage points.

“This rule of thumb is empirical and has literally never failed,” Alfonso Peccatiello, managing director of global macro investment strategy firm The Macro Compass, said in a note. “Of course ‘this time may be different, but markets are now forced to take the possibility of recession more seriously.’

“People rush into bearish trades,” he said. “We went from ‘Goldilocks’ to recession in a week,” referring to the Goldilocks scenario of lower inflation and steady growth that has supported asset prices this year.

SOURCE: ot.gr