After the severe market sell-off following the December FOMC meeting, Powell offered decidedly more market-friendly comments at the January 4 annual meeting of the American Economic Association when he said “muted” inflation expectations would allow the Fed to be “patient” as they watch to see how the economy evolves. Markets responded quickly and vigorously as it became abundantly clear that the Fed had changed course. The “pivot” had begun.
“Patient” became the new watchword as the Fed became incrementally more dovish during the first quarter, and “patient” was interspersed in all of the chairman’s speeches following the January 4 about- face.
Crosscurrents And Conflicting Signals
Crosscurrents and conflicting signals in global economic data releases and surveys prompted the central banks, particularly the European Central Bank (ECB) and the Fed, to assure markets that they were watching and prepared to act. Since the beginning of the year, the Fed funds futures market has predicted zero rate hikes for 2019 and an increasing chance for a rate cut. Going into the second quarter, Fed funds futures see an above-60 percent chance of a rate cut in 2019. Testifying in February before the Senate Banking Committee, Powell said while current economic conditions remain healthy and the economic outlook remains favorable, there have been more signs of “crosscurrents and conflicting signals.” The uncertainty, he explained, was focused on Brexit, ongoing trade negotiations and several “unresolved government policy issues.”
By the March FOMC meeting, the Fed became increasingly more dovish as Powell explained the committee’s decision to remain “patient.” In what would be interpreted as mounting concern by the Fed, it was signaled that there would be no rate hikes in 2019. Importantly, the unwinding of the balance sheet, increasingly seen as a form of additional financial tightening, would be completed in September. “It is a great time to be patient,” declared Chairman Powell. Indeed.
In a recent “60 Minutes” appearance, Powell underscored the message that the Fed is not in a “hurry to change” its rate policy and would monitor the economy to see how it evolves.
Yield Watch Intensifies
Following the FOMC meeting at the end of March, during which the Fed dampened expectations for the economy, Treasury yields fell as investors factored in weakening euro- zone economic data, particularly coming from Germany, the largest eurozone economy, along with weaker- than-expected Chinese data and the prospect of the U.S. economy slowing more than previously expected. On March 22, the yield on the benchmark 10-year Treasury note declined, while the 3-month Treasury bill rate inched higher than the 10-year note, representing an inverted yield curve for the first time since 2007.
The significance of an inverted yield curve cannot be overstated. An inverted yield curve, whether it’s the 10-year Treasury note in relation to the 3-month Treasury bill, or the more commonly referred to 10-year Treasury note in relation to the 2-year Treasury note, reflects investor concerns that longer-term growth is slowing and perhaps evolving towards a recession.
During the past 60 years, according to Evercore ISI research, there has been yield curve inversion before every recession, although there have been three false signals over the same period. Data from Reuters indicate that over the last 50 years, here has only been one false signal from an inverted yield curve. And in August 2018, the Federal Reserve Bank of San Francisco, known for its research on the yield curve, published a paper discussing the 10-year to 3-month yield spread as the most reliable predictor of a recession.