The US Treasury 10 year note fell below 2.4% last night, before closing just over that level, reaching the lowest level since December 2017 and 22bp lower than before last Wednesdays Fed statement.
However, more important is the inversion of the 3 month/10 year spread which traded at -7bp yesterday. This indicator has long been associated with a forecasting tool of an oncoming recession although the timing is difficult. As an old friend of mine who is still a ‘one- handed economist’ teaches, ‘Never predict a market move and the timing of that move at the same time, they are two different forecasts’. But many market participants have jumped in about the power of this ‘tool’ as an accurate indicator of an oncoming recession. We believe in the power of the market as it is the collective wisdom of all, but we also believe in ‘herd mentality’ and of course ‘fear’ of missing out in the market and are conscious that the CFTC reported all time shorts in UST just a few months ago.
While we acknowledge the past accuracy of the 3mth/10 year indicator many observers have been caught out over this cycle looking for history to repeat itself. We do feel that the economy is not as stable as some think and indeed a recession could be on the cards, possibly next year. But the point we would make is that it took 6 years of QE and historically low short rates to get the economy up to a 2% to 2.5% growth rate. But over the last few years both those supports have been withdrawn and in part reversed by reducing the balance sheet at the same time as raising interest rates up to the ‘new normal level’ and so we feel economic weakness has to be expected.
How deep this will be, like the Fed, we are data dependent, but it should also be noted the Fed are probably the best positioned of all the central banks to support the economic outlook, regardless of the future\past repeating.