Fed funds futures were indicating a quarter point in easing Monday, as traders said scary signals continued to emanate from the bond market.
On Friday, there was a purported reversal in the yield curve, which means short rates transcended longer 10-year note rates, a genuinely solid recession signal.
Traders say the bond market may be overreacting, while stocks seem to be ignoring the recession warnings and fears the Fed will have to jump in with one or more rate cuts to stop the economy from rolling over.
The bond market doubled down on terrifying warnings Monday, signaling both a conceivable retreat is approaching and that the Fed could need to cut interest rates this year to stop it.
“People are starting to get fearful,” said Andrew Brenner of National Alliance. “It won’t last for long, but they’re getting fearful about a recession. You had a Fed that changed course 180 degrees and then added to it last week. That caught the market off guard.”
The distinction among stocks and bonds was genuinely emotional Monday, after the bond market flashed a subsidence cautioning Friday. The Dow traded as much as 100 points on the two sides of unaltered Monday, yet the bond market mirrored aflight to safety trade, with yields falling over the bend from the shortest duration securities to the longest. The Dow wound up 16 at 25,516, while the S&P 500 fell 2 points, to 2,798.
The move was likewise worldwide, with the German 10-year bund yield tumbling to a negative 0.03 percent.
In the meantime, there was a lot of activity in fed funds futures, where brokers were wagering on no less than one 25 premise point cut from the Federal Reserve this year and more than two by one year from now. That is a major change from before the end of last year, when the market was all the while expecting interest rate hikes and the Fed was forecasting three.
On Friday, markets were scared when the yield inverted, a dependable subsidence flag however typically not a quick one. That implies the rate on a lower span instrument transcended a more drawn out term security’s yield. For this situation, it was the yield on the 3-month bill, at 2.44 percent Monday, moving over the 10-year yield, which sank as low as 2.38 percent, an over 2-year low. Yields move opposite price.
In another indication of angst, brokers were likewise viewing the 10-year yield Monday as it slid underneath 2.40 percent, about where the fed funds rate is. The 2-year, at 2.24 percent, was well below that level.
“The 10-year is inverted versus the current fed funds. It should signal expectations that rates are going to be lower in the future, which would be consistent with notable risk of a recession,” said Jon Hill, U.S. fixed income strategist at BMO. “One of the fascinating things is the stock market is taking this in stride. The Fed is trying to extend this cycle as long as it can. Whether it will be enough is difficult to say.”
Hill said, however, he believes some of the moves in the market Monday were more about technical signals and short squeezes than real fear about recession. The Fed changed the tone in markets significantly Wednesday, when it was even more dovish than expected and cut its rate forecast to just one for this year from two
Chicago Fed President Charles Evans additionally added to the move when he said on Monday that the Fed could hold or even loosen policy.
The Fed Wednesday discharged a new forecast for no rate hikes this year from two beforehand, yet the market had been as of now been valuing in six premise purposes of a straightforwardness during the current year. After the gathering, it moved to cost in 19 extra premise points, or if nothing else one 25 premise point cut for the current year, as per Hill.
“As far as recession goes, our economist feels quite optimistic that a recession will be avoided, at least this year. The market is focused not only on U.S. fundamentals but also on what’s happening in China, what’s happening in the rest of the world and how likely it is that political uncertainty, whether through trade policy or whatever, how likely is that to persist and beget a recession,” said Mark Cabana, head of short U.S.rate strategy at Bank of America Merrill Lynch.
Strategists said the bend reversal does not really mean a recession is coming but it could. Stocks also historically have done fairly well immediately following such a move.
“As recession signals begin to flash and recession probabilities increase, I would expect market participants and people who deploy capital will become more cautious and there’s a risk that it’s a self-fulfilling prophecy,” Cabana said.
Brenner said the 10-year yield is getting ahead of itself but for now it cold still go lower. He said the market was bracing for about $350 billion in new U.S. debt this week in both notes and bills.
“We have the cheapest rates in a long time. You’re in the last week of a quarter plus it’s Japanese year end. All the things that are affecting it aren’t going to be affecting it next week,” said Brenner.