Even after the 2-year Treasury yield has risen 39 basis points from the intraday lows of Monday, the bond market is still priced for 4 Fed cuts (-1.03%) through the end of the year with three meetings left. This would mean 50 basis points in September and 25 basis points in November and December. Given how little has happened, this is still too much.

The economic data last week was soft, but not yet recessionary. In a Bloomberg article yesterday, Claudia Sahm, creator of the Sahm rule, explained that despite her indicator triggering, a recession hasn’t begun yet. I’ve been highlighting this too, here and here. Non-farm Payrolls would typically be negative if a recession had begun, but Friday’s number was +114k. Less discussed, but just as important in dating a recession, Consumer Spending (PCE), Industrial Production, and real Personal Income made new highs last month. Some, if not all of these, should be falling to suggest a recession.

In 2007, the Fed started a rate cutting cycle with 50bps before the recession began (about 2.5 months), but this was after a material rise in credit spreads and several well publicized mortgage fund and firm blow-ups. The statement from that meeting read;

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally.  Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year.  However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook.  The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.”

Given that stock market and credit-spread moves have been reasonable in the U.S., it is hard to imagine what the Fed would replace those italicized statements with now to justify a 50-basis point cut. This 50bps cut came after HSBC announced losses from subprime mortgages in February 2007, New Century Financial filed for bankruptcy in April, two Bear Stearns mortgage funds closed in July, the ECB, Federal Reserve, Bank of Canada, and the Bank of Japan began to add liquidity to markets in August, and British Pound Libor surged to more than 100 basis points over the central bank rate in September. There is none of that now.

I would gauge last week’s economic data and the Fed’s hawkish pivot to justify 2-3 rate cuts by the end of the year, not the 4 that is priced-in. Where last month, there was a gap between weaker data and higher yields, this has now reversed where yields moved lower more than the data has. Any hints of better economic data are going to cause rates to rise. Case-in-point: Initial Jobless Claims was released this morning, improving 16k from last week, which normally wouldn’t mean anything to the market, but the 2-year jumped higher by 6 basis points.

Don’t confuse any of this for not thinking a recession is coming soon. Remaining long bonds is important because nobody knows when the next shoe will drop.  Between the unemployment rate rising, the inverted yield curve, and deep drawdown in the Leading Economic Index (-15%), a recession is almost certainly coming, but I also notice a material distance between the bond market and the Fed which may assert itself with higher short-term yields in coming days and weeks.