The Federal Reserve Board (FRB) gave markets a gift last week. This gift may prove to be just the thing we did not need.

The Decision

The FRB announced last week that they are likely not to raise rates again in 2019. They also announced that they will be closing out their balance sheet run off in September. Their current projects reduce 2019 GDP expectations from 2.3% to 2.1%. Additionally, they announced their expectation that inflation will be maintained at its current level given the growth rate.

The Gift

This gives markets reason to celebrate. The FRB is indicating that they are going to leave monetary policy loose in the near-term future. . This allows lending to expect little change in rates, financial conditions will not tighten, and inflation remains a non-issue.

The Risk

The projections of future growth often tie into long-term treasuries rates. As the FRB backs off their growth targets for the US economy, we see 10-year treasury yields fall.  They have fallen below the yield on the 3-month treasury; inverting yet another part of the yield curve. This sent US markets spiraling downward on Friday, erasing all the gains from earlier in the week.

The Reality

The stronger indicator of a recession would be when the 2-year treasury earns more than 10-year treasuries. The 2 & 10 indicator has yet to be breached with approximately .13% difference between the two. A level of separation that has been fairly consistent over the last year and a half.

Additionally, even the 2 & 10 curve is not quite the indicator it has been in years past. The FRB took extraordinary measures to bring us out of the last recession, leaving them with $4B of Mortgage backed securities and US treasuries on their balance sheet. By not trading on those securities, they are keeping interest rates artificially low. If those securities were actively traded, perhaps there would 1.5% difference between the 2’s & 10’s, no one knows. That being the case, a breach of the 2 & 10 curve does not necessarily mean a recession is certain.

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