A closely watched recession indicator is flashing again after the minutes of the Federal Reserve’s June meeting revealed another large rate hike could be coming this month.
The closely watched spread between the 2-year and the 10-year Treasury yield further inverted upon release of Fed’s June meeting minutes, which suggesting another rate hike is on the way as policy makers scramble to cool piping hot inflation.
The treasury yield curve is notoriously reliable for predicting an upcoming recession, as it inverts when bigger returns on debt – and therefore, bigger economic risks – are expected in the short-term.
Yields on the 2-year treasury inched up nine basis points to 3.05% as of 11:00 a.m. ET, marginally above the 10-year treasury yield of 3.01%.
There’s solid evidence that supports the yield curve’s ability to predict recessions. An inverted yield curve predicted the 1990, 2001, and 2008 recessions, according to a note from DataTrek this week. But an inversion can only predict a downturn if it sticks around for a few months, as brief spikes in the 2-year Treasury yield above that of the 10-year historically haven’t indicated much, as illustrated in moments when the curve inverted in 1998 and 2019.
The 2- and 10-year yields have inverted several times this year already, as investors expect the Fed’s rate hikes to fight inflation at the expense of economic growth. June’s meeting minutes suggested the central bank remains hawkish even after delivering its largest rate increase since 1994 last month, and that it could be gearing up to hike by the same amount at its upcoming meeting.
The consumer price index surged to 8.6% in May, the most severe rate of inflation in 40 years.
“Most participants judged that 50 basis point increases in the target range would likely be appropriate at the next couple of meetings,” the Fed’s release said, slightly lower than the 75-point rate hike some experts have suggested, though it could still hike by three-quarters of a percent if there is a risk inflation is becoming entrenched.
The Fed’s dramatic policy tightening has been the major headwind to markets in 2022, and economists believe there is substantial risk the central bank misses the “soft landing” and steers the economy into a recession as it battles rising prices. Fed chief Jerome Powell, however, has said the risk to the economy is acceptable given the greater threat posed by inflation.
“Elevated inflation could become entrenched if the public began to question the resolve of the Committee to adjust the stance of policy,” the Fed release said, suggesting the central bank thinks another hike is necessary to regain public confidence.
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