One of the bond market’s most reliable gauges of impending U.S. recessions plunged further below zero into triple-digit negative territory on Tuesday after Federal Reserve Chairman Jerome Powell pointed to the need for higher interest rates and a possible reacceleration in the pace of hikes.
The widely followed spread between 2- and 10-year Treasury yields finished the New York session at minus 103.7 basis points — a level not seen since Sept. 22, 1981, when it reached minus 121.4 basis points and the fed funds rate was 19% under then-Federal Reserve Chairman Paul Volcker.
Powell surprised financial markets on Tuesday with more hawkish comments than many expected, which sent the policy-sensitive 2-year rate above 5%, all three major stock indexes DJIA, -1.72% SPX, -1.53% COMP, -1.25% to lower finishes, and the ICE U.S. Dollar Index up by 1.2% to its highest level since January.
Meanwhile, traders boosted the odds of a half-of-a-percentage point rate hike on March 22, to 70.5% from 31.4% a day ago, and saw a growing chance that the fed funds rate will end the year between 5.5% and 5.75% or higher, according to the CME FedWatch Tool.
“Every time the Fed gets more hawkish, the curve gets more inverted, which is the market’s way of saying there will be Fed rate cuts later because of a slowdown in growth and/or a recession,” said Tom Graff, head of investments for Facet in Baltimore, which manages more than $1 billion. “It tells you what the market thinks about the sustainability of keeping rates this high for a long time, and the market still thinks a recession is pretty likely but not necessarily imminent.”