Has recession already been averted?
As of July 19, 2019, less than two weeks before the Fed’s July meeting, a Fed rate cut is a virtual certainty.
The question now is not whether the Fed will cut, but rather how much. As of the 19th, the futures market showed a 63% probability of a 25-basis point cut and a 37% probability of a 50-basis point cut.
The beginning of the Fed’s last three rate-cutting cycles were all marked by inversion of the yield curve, i.e., the yield on the 10-yr Treasury falling below the yield on the 2-yr Treasury. In the chart, this is indicated by the dark blue line crossing above the gray line. Moreover, the last three curve inversions were also associated with the onset of recessions.
In late 2018, the slope of the yield curve reached its flattest point since 2007 (highlighted by the green circle), but avoided inversion, and has been steepening ever since on the back of dovish forward guidance from the Fed. Might this mean that recession has been averted?
The potential for recession is nothing to take lightly, but perhaps the most important difference between the beginning of previous rate cut cycles and today is the stance of Fed policy. In all three previous cases, the Fed Funds Target Rate was much higher and the Fed’s balance sheet was much smaller.
On the whole, policy was much tighter than it is now, leaving the Fed a lot more policy fire power to work with.
With that in mind, market participants will likely keep a watchful eye to see if and how the difference between today’s policy and that of previous years will affect its efficacy in averting a recession.
Unless otherwise noted, data is sourced from Bloomberg.
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