Jay Powell fails to bend yield curve to his will
The Federal Reserve’s quarter-point interest rate cut on Wednesday failed to have the desired effect on a widely followed bond market indicator of recession.
The yield curve — reflecting the difference between the yields on three-month and 10-year US Treasury bonds — dropped further into negative territory, settling at minus 5.5 basis points.
The measure has turned negative or “inverted” before every US recession of the past 50 years, and analysts said the development indicated that investors doubted the central bank had acted decisively enough to shore up the US economy.
Analysts also noted that another closely watched portion of the yield curve — the difference between two-year and 10-year Treasury yields — collapsed to its narrowest gap in four months, while the US dollar rose as much as 0.6 per cent versus its peer currencies.
“The clear signal coming from the strengthening of the dollar and the flattening of the yield curve is that the market is crying out for more accommodation,” said Subadra Rajappa, head of US rates strategy at Société Générale.
She said investors were worried that the Fed would not deliver as many cuts as they had anticipated. Fed chairman Jay Powell called the 25bp cut a “mid-cycle adjustment to policy” that was “not the beginning of a long series of rate cuts”.
Markets had priced in almost 100bp of cuts in the next year before the Fed acted on Wednesday. Now traders reckon there is an almost 40 per cent chance the Fed will leave rates unchanged in September, up from 25 per cent earlier this week.
Krishna Guha, head of global policy and central bank strategy at Evercore ISI, said the yield curve move reflected the Fed’s messaging.
“How do you un-invert the yield curve? You cut aggressively at the front end, but also do so in a way that convinces people that the growth outlook will be stronger so longer-terms yields rise,” he said.
“If the Fed raises a little bit of doubt or confusion about how strong the commitment is to be aggressive and pre-emptive with interest rate cuts, you can see how mechanically that would lead to a more inverted curve,” he added.
Robert Tipp of PGIM Fixed Income said that as a result of the Fed’s “hawkishness”, the US central bank had tightened financial conditions.