Wall Street's favorite recession indicator flashes red

A closely watched recession predictor in the bond market has just turned red, sparking fresh concerns that The US economy is on track for a slowdown this year due to the Federal Reserve’s war on inflation.

The spread between 2-year and 10-year Treasury yields reversed this week for the first time since April on fears that the Federal Reserve’s aggressive approach to tackling the highest inflation in four decades lead to a lasting slowdown in growth. The phenomenon – which is rare – has been a historically accurate predictor of recessions.

INFLATION TIMELINE: MAPPING THE BIDEN ADMINISTRATION’S RESPONSE TO RAPID PRICE GROWTH

Yields on 2-year Treasury bills climbed as high as 3.431% in morning trading on Tuesday, outpacing those on 30-year bonds, which fell to around 3.277%. The move reflects “fears of a Fed policy error and an impending recession,” according to Mark Hackett, head of investment research at Nationwide.

A man wearing a mask walks past the U.S. Federal Reserve building in Washington DC, U.S. April 29, 2020. ((Xinhua/Liu Jie via Getty Images) / Getty Images)

Yield curve inversions are considered a good predictor of recession because they suggest that investors think – with the interest rate on long-term bonds lower than on short-term bonds – that economic growth slows down. Every recession in the past 60 years has been preceded by an inverted yield curve, according to to research of the Federal Reserve Bank of San Francisco.

‘UGLY’ INFLATION REPORT COULD PUT FED’S 75bps RATE HIKE ON THE TABLE

There are growing fears on Wall Street that the US central bank could trigger a slowdown by raising interest rates at the fastest pace in two decades following a steamy report from the labor department released last week which showed the consumer price index rose 8.6% in May from a year ago, faster than expected. It marks the fastest rate of inflation since December 1981.

Wall Street stocks

Traders work on the floor of the New York Stock Exchange (NYSE) on June 10, 2022 in New York City. (Photo by Spencer Platt/Getty Images)/Getty Images)

The dismal inflation report confused investors and caused traders to reconsider their expectations for Fed rate hikes this year. Wall Street banks Barclays and Jeffries are now forecasting a 75 basis point hike – the first since 1994 – following the Fed’s policy-setting meeting on Wednesday. A majority of merchants – around 96% – also expected a large rate hike this month, according to CME Group’s FedWatch tool, which tracks transactions.

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“The US central bank now has good reason to surprise markets by increasing more aggressively than expected in June,” Barclays strategists wrote in a note on Friday. “We realize this is a close call and it could play out in June or July. But we are changing our forecast to see a 75 basis point upside on June 15.”

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