With the S&P 500 now up 23% from its October 2022 lows, you’ve probably seen headlines declaring a new bull market and a rosy outlook ahead.
But if you really want to know where the economy is headed next, you need to watch the bond market.
That’s because moves by the Federal Reserve show up directly in the bond market.
So while the stock market is volatile and noisy, the bond market is where you can find reliable signals for the economy based directly on the Fed’s actions.
And unfortunately, even as the investor mood turns jubilant, signals from the bond market are sending a very different message…
How the Fed Manipulates Rates and the Economy
As a reminder, the Fed manipulates the economy directly by raising or lowering interest rates. It does that by moving the rate that banks use to lend on overnight loans – or the Federal Funds rate.
As a result, shorter maturities, like the 3-month Treasury bill, closely follow the Fed’s actions.
The Fed has been jacking up the Fed Funds rate at the fastest pace since the 1980s. So the rate on 3-month bills is also skyrocketing.
In fact, the 3-month bill is at the highest level in over 20 years.
Right now, short-term rates are way higher than long-term rates. The difference between the two is called the yield curve.
When short-term rates are above long-term rates, the yield curve is said to be inverted. And an inverted yield curve becomes a self-fulfilling prophecy for tanking the economy.
That’s because banks pay a short-term rate on deposits. They also collect the interest from longer-term loans they give out, like your mortgage.
And in a healthy economy, the short-term rate is less than the long-term rate. That helps banks stay profitable.
But when shorter-term rates rise more than the long-term rate, that’s a sign that bank profits are being compressed.
In other words, it means banks are paying more on deposits than what they are collecting on their loans.
So giving out loans becomes less profitable. And it leads to banks pulling back on lending.
A pullback in lending cascades through the rest of the economy.
Our economy is built on access to credit. So when both consumers and businesses have less access to money… that means less spending on things like homes or factory expansions.
The Fed tracks the odds of a recession caused by an inverted yield curve and a bad lending environment.
And this indicator is currently flashing the worst signal in four decades.
The Highest Odds of a Recession
Banks are holding on for dear life to keep their profits high.
They’ve done that by refusing to pay a higher rate on deposits, which is leading customers to pull their money out. This created the liquidity crisis we first saw in March when three U.S. banks went belly up.
Here’s how Inside Wall Street’s editor Nomi Prins put it recently:
Silvergate Bank, Silicon Valley Bank, and First Republic Bank offered lower deposit rates than their peers and competition.
So depositors had no real incentive to keep their money. It was a game of chicken and the regional banks blinked. As rates were rising, depositors turned elsewhere to get better interest returns on their deposits.
But now, out of fear of being the next bank to go under, many banks are changing their minds. They’ve begun to pay higher rates on their deposits, which will lead to a crunch in bank profits.
And as described above, a crunch in bank profits means a pullback in lending.
That’s why the yield curve is so important. It shows if our economy is running smoothly.
In fact, the yield curve is so important that the Federal Reserve built their own recession probability model based on it.
And right now, it’s signaling the chance of a recession unfolding over the next year at 71%. Take a look below.
As you can see, the Fed is predicting the highest chance of a recession in 40 years.
And that recession can happen as soon as May 2024…
What This Means for Your Money
Overall, the Fed manipulates the bond market to achieve its desired outcome.
It targets banks through the yield curve. And by causing banks to pull back on lending, it intentionally causes a recession.
We’re already witnessing the unintended consequences of the Fed’s actions. Bank failures this year are even eclipsing the carnage seen during 2008’s financial crisis.
And I expect there’s more fallout to come.
In fact, on July 31, the Federal Reserve and financial elites are set to enact a major change to the very nature of our money.
It will upend the way we interact with the financial system – and the way the financial system interacts with us.
And with the recession indicators flashing, now is not the time to sit idly as this situation unfolds.
That’s why my colleague Nomi Prins hosted an emergency briefing last night called Countdown to Chaos. In it, she explained what’s about to happen to our financial system… and how you can position yourself ahead of what’s coming.
If you missed it, you can watch the replay by clicking here.
Remember, don’t get swayed by signals from the stock market. While investors breathe a sigh of relief that there’s a better economy ahead, there’s a more sinister message coming from bonds.
Regards,
Clint Brewer
Analyst, Rogue Economics
P.S. In her special briefing last night, Nomi revealed one way you can prepare for the volatility that’s about to ripple through our markets.
It involves one little-known asset with the potential to deliver as much as 50x profits.
If you missed the event, click here to watch the replay. But make sure you do it quickly before our publisher takes it down.