An inversion of the long end of the curve is counterintuitive given the Fed’s looming tapering announcement, but the flat forward curve—measured by the three-year forward 3-month/10-year swap curve—indicates that the market is likely looking ahead to the economic impact of the hiking cycle to follow. We expect the Federal Open Market Committee to announce the tapering of quantitative easing at its Nov. 3 meeting, with purchases likely to end in mid-June 2022. We have also moved forward our expectation that fed funds rate hikes will begin in the fourth quarter of 2022. A rapidly tightening labor market and a persistent overshoot of the inflation target may justify raising the fed funds target to a terminal range of 2.00–2.25 percent.
History shows that an inverted 20s/30s curve on its own does not necessarily predict a recession, but the flat forward curve has been a stronger indicator. The three-year forward 3-month/10-year swap curve stands at just 26 basis points, and based on data from the last three business cycles, that level has historically preceded recessions by an average of 28 months.
Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility.
Basis point – One basis point is equal to 0.01 percent.
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