Will the Fed go too far? Violent stock market swings keep investors on the lookout for signs of recession

The nosedive followed a brief rebound on Wednesday after Federal Reserve Chairman Jerome Powell pulled the trigger on a much-anticipated 50 basis point interest rate hike, the biggest since 2000.

It also came as the focus shifted from Powell’s comments that a larger 75 basis point rate hike was not something the Fed was actively considering, to what else he said, namely that the Fed will not “hesitate” to offer higher interest rates. if they are necessary.

“Up, down, up, down, but largely down, it looks like the market is headed down indefinitely,” Brad McMillan, chief investment officer at Commonwealth Financial Network, said in emailed comments Friday.

But despite all the drama in equities, there was another noteworthy move in a key part of the bond market. The benchmark 10-year Treasury yield TMUBMUSD10Y,
3.035%
briefly topped 3.20% on Monday, after ending the week at its highest level since Nov. 13, 2018, according to Dow Jones Market Data.

That rate plays a big role in the price of everything from corporate debt to commercial real estate loans. Its latest move higher also brings it closer to a previous high of around 3.25% in 2018 (see chart), or before it declined before the pandemic-sparked 2020 recession.

The 10-year Treasury found a high near 3.25% in 2018 before the 2020 recession hit

Board of Governors of the Federal Reserve System.

Like watching yield curve inversions, the 10-year Treasury yield also has a history of signaling recessions before they happen.

“Those bonds spot a recession quicker,” Bill Callahan, investment strategist at Schroders, told MarketWatch. “If the Fed keeps raising rates without regard to what’s happening in the economy, those rates will peak.”

recession signs

Looking at the past on Wall Street doesn’t necessarily predict the future, particularly when comparing 2018 to 2022.

“The circumstances are different, in the sense that the inflationary pressures are much more pronounced and real,” Jimmy Whang, head of credit and municipal fixed income at US Bank, said by phone.

“And the current situation with Russia’s war in Ukraine, coupled with the pressures with the zero COVID policy in China are obstacles to addressing the supply side of the equation,” he said on Friday.

That’s why Whang thinks the 10-year yield could trend higher than in the past before finding a new pre-recession peak.

“What we’ve seen in terms of market performance seems to suggest we’re heading into a somewhat challenging environment in terms of the Fed navigating a soft landing,” he said.

US stocks fell on Monday after ending a turbulent week in the red, adding to yearly declines, with the S&P 500 SPX Index,
-3.20%
almost 16% in 2022, the Dow DJIA,
-1.99%
discount of 11% and the tech-heavy Nasdaq COMP Composite Index,
-4.29%
25% lower.

In addition to a rise in Treasury yields, a major factor in this year’s painful bond market crash, the yield on US junk bonds recently topped 7%, according to the ICE BofA US High Yield Index. . or the highest level in about two years.

“We’re in a new regime if we think about coming out of the global financial crisis,” said John McClain, portfolio manager for high-yield and corporate credit strategies at Brandywine Global Investment Management.

“Until the end of last year, central banks were in the business of suppressing volatility and coming to the rescue of the markets,” McClain said by phone. “The opposite is true today.”

Where does that leave the markets? Steve Friedman, a senior macroeconomist in the fixed income team at MacKay Shields, said a lot depends on what happens to inflation, pegged at an annual rate of 8.5% in March, over the next several months as the Fed raises rates. rates.

“There is a sense that policy is going to have to go into tightening territory next year,” said Friedman, a former Fed staffer, even if it means sparking a recession.

“I think there is justifiably concern about how a soft landing occurs,” he said. “The narrative is a bit lame for market participants and lame for me.”

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