The S&P 500 recorded an impressive gain of ~7% for the first quarter. Optimistic on the resolution of the banking crisis – and prospects of Fed rate cuts in the second half – the bulls have regained their mojo. But this raises a question: why would the Fed cut rates? It’s not because inflation is under control. For example, could it be because the economy needs assistance? Stress in the financial system? A credit event? If so, is that a good thing? Here I also look at the monthly chart – it deserves our attention.
Fed Reserve
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Yield Curve: Recession Dead Ahead
2-year bond yields are cratering. Rarely – if ever – have we seen them fall 150 basis points in just three weeks. This signals the bond market sees aggressively rate cuts from the Fed this year. But what would cause this? A recession? Some kind of credit crisis? I can tell you it won’t be because inflation is back to the Fed’s target of 2%. What’s more, the yield curve has steepened sharply. This isn’t good… and if history is any guide… a recession is likely within 12 months.
Market vs The Fed
There is strongly divided opinion on whether the Fed’s decision to raise 25 bps this week was the right thing to do. What should the Fed prioritize? Financial stability or prices of goods and services? The Fed chose the latter. However, Powell added he does not see rate cuts in his base case for 2023. However, that’s not what bonds are pricing in. They see the Fed cutting rates by a further 100 bps this year. A reckoning is coming… one of them has it wrong.