I’ve been wrong with my short-term call in the last two weeks, thinking that interest rates would move higher surrounding the Fed. They have fallen dramatically. Economic data this week has been negative (ISM, Initial Jobless claims, and Unemployment/payrolls.) That, combined with the Fed’s 2nd pivot on Wednesday, the stock market falling continually, and the Sahm rule being triggered today, has caused the market to price-in a lot of Fed easing with a low 2-year yield.

There are now 4.5 0.25% cuts (1.125%) priced in for the rest of the year essentially meaning the Fed would be cutting 50 basis points at two meetings (there are three left this year), and there are 8 cuts priced in over the next year; one at every meeting. This isn’t so unusual for a recession scenario, but the bond market is jumping ahead by a chapter. JP Morgan is saying the Fed should cut inter-meeting before September, but the banks just want to protect “risk-on” assets. The market is expecting the Fed to panic-cut interest rates beyond what they did in 2007 (the first cut was 50bps then) but there are five things I see that don’t align with that.

1. The Sahm rule, which triggered today, suggests the economy is already in recession by history but it is clearly not. The Conference Board’s Coincident Indicator series needs to make a peak to signal the top of the business cycle, but it rose to a new high this month and last, with three of the four indicators making new highs this month. By the Sahm rule history, and the assumption being made by the markets, there should’ve been a peak several months ago (an average of four.) One of the Coincident Indicator components is Non-farm Payroll Employment and if we were in a recession, we would be seeing negative/shrinking numbers by now. We haven’t seen a negative number yet.

2. No credit event so far. The 50-basis point cut in August 2007 was because credit problems were becoming acute. They began in February 2007 with several high-profile defaults/fund closures in the meantime (New Century Financial, Bear Stearns, BNP Paribas). The high-yield corporate spread was 4.3% at that cut, it is a full percent lower now.

3. The Fed will speak. Upcoming Fed speakers aren’t going to sound like market commentators are sounding. They still want to keep financial conditions tight until they know that lower rates aren’t going to re-ignite inflation like before. So far, there is nothing in particular to panic about. Dovish Austan Goolsbee was on Bloomberg this morning saying “we never want to overreact to one month’s numbers”, was alluding to the mistake markets made last December in pricing in too many cuts, and saying that markets tend to jump [to conclusions].

4. The 2-year yield is extremely overbought (RSI, 14-day), marking a condition that has occurred only 4 other times in the last 35 years. It is the only time outside of major geopolitical events (USSR dissolution, LTCM collapse, COVID-19) that it has moved down this fast. This is certainly not one of those times.

5. Based on my subjective weightings, the negative data this week still does not offset the positive data of the prior weeks (see black circle below)

From all this, I expect yields to rise somewhat as Fed speakers will be trying to reel the market back in from going too far, and there will inevitably be some more positive economic data. But, I wouldn’t expect too much from this back-up, the recession is too close now for another major backup. If a back-up occurs, it will be a buying opportunity. The data this week further confirm that a recession is coming, but I don’t think it is as imminent as markets think it is.