Bond market signals slowing growth could be ahead.
What a difference a few months make.
The Federal Reserve sharply transitioned to dovish monetary policy this past Wednesday leaving its key policy rate unchanged at a range between 2.25% and 2.50%, and indicating that more interest rate hikes aren’t likely for 2019. That represented a U-turn from previously signaling in December that two rate hikes were possible.
The Fed also trimmed its forecasts for economic growth and said it would end its balance sheet “normalization” this year – ending quantitative tightening in September, earlier than planned. The Fed’s median forecast for growth in the nation’s gross domestic product (GDP) for 2019 was lowered to 2.1%, from a 2.3% forecast last December, and 1.9% in 2020 from December’s projection of 2.0%.1
Among the big winners in financial markets were U.S. Treasury securities, though possibly for the wrong reasons (more on that below). Since the Fed has changed course, the yield on the benchmark 10-year Treasury note has declined to its lowest since January 2018, settling at yield of around 2.54% as of March 21, and has even drifted below the 2.50% level. To step back, 10-year note yields were nearly 3.25% near the start of the fourth quarter of 2018.
Rather than, perhaps, view the falling yields and rising prices in the bond market as a rally, one can also take it as a sign that investors see recession risks closer around the corner than they did prior to the Fed releasing its assessment for rates and economic growth.
“All anyone needs to do is read the first paragraph of the Fed press statement to see that the central bank has marked down its assessment of the economic landscape – the choice of words suggests far more than the tweaking that was done to the numerical projections,” David Rosenberg, chief economist and strategist at Gluskin Sheff, said in a note on March 21, cited in this CNBC report.2
In its March 20 statement, the Fed said that “growth of economic activity has slowed from its solid rate in the fourth quarter,” and that recent indicators “point to slower growth of household spending and business fixed investment in the first quarter.” The Fed’s statement added that overall inflation has declined on a 12-month basis, largely the result of lower energy prices, while inflation excluding food and energy remains near 2%. Wage inflation also has remained low.3
Rosenberg also noted that real 10-year yields, after adjusting for inflation, were below those of the last U.S. recession, and that it would be foolish for stock investors to disregard recent movements in the Treasury yield curve – which plots rates from 3-month Treasury bills up to 30-year bonds. “The real yield [compared to inflation] on a 10-year note has collapsed to a 14-month low of 0.56% – it never got this low during any part of the 2008/09 Great Recession, for some perspective,” he said.
As of March 21, the difference in yields between 10-year notes and 3-month T-bills was about 14 basis points, though that area of the yield curve did invert during trading on March 22 for the first time since 2007. A flat to inverted yield curve indicates that the economy could be transitioning from growth to recession, and has historically been a predictor of growth slowdowns.
Another key point for those parsing the Fed’s statement is that the central bank’s median forecasts now show that projections of the federal funds rate at 2.40% for 2019 and 2.60% for 2020 and 2021 are below the 2.80% longer-run interest rate – or the rate that would prevail when the economy is at full employment with stable inflation and the absence of any further economic shocks.
Writing in his Marc to Market blog, Marc Chandler, managing partner and chief market strategist at Bannockburn Global Forex, recounted how the Fed stuck by its view that the economic expansion is most likely to continue with inflation near target. “However, the median forecast now expects that the interest rate cycle will be completed without the Fed being able to raise the fed funds target range to its long-term equilibrium rate. In effect, they judge the economy as still requiring monetary support,” he wrote. “This is the disconnect: An economy expected to grow above trend but still requires monetary policy.”4
1 Federal Reserve. (2019, March 20). Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents under their individual assessments of projected appropriate monetary policy, March 2019. Retrieved from: https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20190320.pdf
2 Cox, J. (2019, March 21). The bond market is flashing its biggest recession sign since before the financial crisis. CNBC. Retrieved from: https://www.cnbc.com/2019/03/21/a-key-recession-indicator-just-did-something-that-hasnt-happened-in-12-years.html
3 Federal Reserve. (2019, March 20). Federal Reserve issues FOMC statement [Press Release]. Retrieved from: https://www.federalreserve.gov/newsevents/pressreleases/monetary20190320a.htm
4 Chandler, M. (2019, March 20). FOMC: Above Trend Growth Requires Continued Monetary Support. Marc to Market. Retrieved from: http://www.marctomarket.com/2019/03/fomc-above-trend-growth-requires.html
Sources for Market Data:
10-Year Treasury Note:
3-Month Treasury Bill:
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