During the Federal Open Market Committee press conference this week, Federal Reserve Chairman Jerome Powell said he did not believe the economy is in recession, noting that the broader economy continued to grow and employment remains solid. Alongside Powell’s comments, the forward market is another source of insight about the business cycle and prospects for a near-term recession.
The forward market implies that the conventional recession definition of two consecutive quarters of negative growth is not yet consistent with an actual recession.
Why is that? The forward market tends to correctly anticipate the direction and level of three-month Treasury bill rates, discerning the direction of Fed policy. After briefly trading at 3.75% to 4% in June when inflation fears were at their worst, forward rates for three-month T-bill rates in two-years’ time have dropped to less than 2.8%.
This implies a possible monetary policy pivot toward lower rates by the second half of 2023 as the Fed turns its attention to the other portion of its dual mandate—maximum employment, as opposed to the current focus on price stability—and focuses on reviving a faltering economy by once more reducing the cost of capital via cuts in the Fed funds rate.
The spread between the forward rate and the current level of the three-month T-bill rate should therefore anticipate the length of the business cycle. As we show below, the forward spread has turned negative in the runup to the previous three recessions.
In the current episode, however, the spread remains positive, but just barely. So, while the sharp drop in the spread indicates an anticipation of a slowdown in growth, it has not yet called for a quick end to the current business cycle. Instead, at this point the markets appear to be opting for a shallow dip in economic growth rather than a “double-dip” recession.
