Another Rate Hike as Concerns About a Recession Increase

Yesterday, the Federal Open Market Committee (FOMC) raised interest rates by 75 basis points (bps). This was third consecutive time the FOMC has raised rates by this magnitude. Cumulatively, this year’s five rate hikes total 300 bps (3.0%).

The last time the target for the federal funds rate was at this level was January 2008.

Bond yields are also at multiyear highs. Yesterday’s closing yield of 3.51% on the benchmark 10-year Treasury note was the highest since 2011. 

In the backdrop of this is a general downtrend in inflation expectations. The 10-year breakeven inflation rate was 2.38% yesterday, down from a multiyear peak of about 3.00% in April. The five-year breakeven rate was 2.47% yesterday versus nearly 3.60% in March.

Worries about inflation are starting to be overshadowed by worries about a recession. Corporations, for instance, are mentioning the “R-word” with much greater frequency, as Matt Markowski noted in his Stock Superstars Report commentary last week.

“Of the [S&P 500 index] companies reporting second-quarter results, 240 of them mentioned the word ‘recession’ during their earnings calls,” wrote Matt citing data from FactSet. “This is the highest number of companies to do so since 2010. It also is much higher than the five-year average of 52 companies. The previous record of 212 companies occurred after the first quarter of 2020 when the coronavirus pandemic arose.”

A more widely used recession forecasting tool is the Treasury yield curve. Inverted yields have historically been a harbinger of recessions. With about a week to go into the quarter, interpretations depend on how one looks at the yield curve.

Duke professor Campbell Harvey, who first found the link between inverted yield curves and recessions, compares the three-month Treasury bill yield to yields on five- and 10-year Treasury notes. Based on his time span of a full quarter, the yield curve has not fully inverted for the full third quarter. The average quarter-to-date yield for the three-month T-bill was 2.68% as of yesterday. It was 3.13% for the five-year note and 3.02% for the 10-year note. Harvey says a very flat curve “suggests slower growth.”

Others plot the two-year Treasury note yield against the 10-year note. Currently, this relationship is inverted. The average quarter-to-date yield for the two-year note is 3.28%, above that of the 10-year note. If you look at the daily data instead, the curve is clearly inverted, with the two-year note yielding 4.02% yesterday, well above the 10-year note’s yield of 3.51%—a recessionary signal.

The FOMC, for its part, cut its full-year projection for real (inflation-adjusted) gross domestic product (GDP) growth. Real GDP is now forecast to be up 0.2% for the year. In June, the FOMC projected 1.7% growth. Federal Reserve chairman Jerome Powell acknowledged that the “chances of a soft landing diminish” with how restrictive monetary policy becomes. And we know the FOMC doesn’t have a good record of achieving soft economic landings. Still, a recession is not guaranteed; only the risks of one occurring have increased.

There are upsides and downsides. We’re earning more interest on our savings accounts and bond yields are juicier than they have been in a long while. Stock valuations are also lower than they’ve been in recent years. The negatives include slower-than-anticipated economic growth, the potential for (but not the probability of) more downside for the stock market and higher borrowing costs for both consumers and corporations.

Most importantly, you still have options available to you. They range from cutting back on spending to being opportunistic in seeking higher yields on savings accounts and bonds as well as stocks whose valuations have fallen to attractive levels. Even in times when clouds seem to be gathering, there are opportunities for savvy savers and investors.