Friday's Market Minute: Exaggerated Market Mania & Recession Fears

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Equity and fixed-income markets have been hard hit this year as investors mark down global growth forecasts while the Fed is pulling liquidity from the financial system. The Fed announced its first 50-basis-point interest rate rise in more than twenty years, with markets initially advancing on what appeared to be a tone that was much more balanced than at the January and March FOMC meetings.

Yesterday, ten- and thirty-year Treasury yields traded above the 3% psychological level, and the bulls became entangled in a trap. Volatility remains elevated, and the magnitude of daily swings this week have done severe damage to both bulls and bears alike.

 Not as hawkish as expected doesn't necessarily equal dovish, and Powell was explicit that fighting inflation is his chief objective. The Fed is set to continue to raise rates, and markets have been pricing this in for the past few months.

In addition to ratcheting up the overnight lending rate, the declining balance sheet will make a longer-term advance in the S&P 500 very challenging. Regardless, the Fed will be raising rates aggressively and will look to get the Fed Funds rate close to 3%, which closely tracks the two-year Treasury yield. 

Whether the bear market correction continues or not depends on whether the Fed's monetary policy tightening causes the recession. If not, the current S&P drawdown might be near the bottom, and it will be recorded as a sub-20% correction. Investor sentiment is dour, and advanced recession fears now permeate headlines. However, the financial markets are currently not pricing in an imminent recession.

Specifically, the spread between the Treasury yield on a 3-month bill and the 2-year note is still positive, despite the flattened spread between 5’s and 30’s. Therefore, the probability of an imminent recession is very low. Once the yield on a 3-month Treasury bill reaches and exceeds the yield on a 2-year note, the market will start pricing an imminent recession. In response, the Fed will begin lowering the Federal Funds rate while the unemployment rate will start to rise. We are currently nowhere near this point.

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This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.