Bank of America says that the US could see prices drop like a rock without going into recession.
Bank of America says that inflation could be about to drop a lot, and prices could drop a lot without the US going into a slump.
Strategists pointed to the flattened 2-year and 10-year Treasury yield curve, a well-known recession indicator from the bond market that has been right many times, most recently in 1990, 2001, and 2008. When short-term bond yields rise above long-term bond yields, this has been a sign in the past that investors think a downturn is coming.
Last week, the difference between the 2-year and 10-year Treasury yields grew to a full percentage point. This is the biggest difference between the two rates in over 40 years.
This time, however, the sign shows that inflation is headed for a hard landing, the bank said, and the US economy is still likely to avoid a sharp drop.
“Curve inversion at historical extremes has made models predict a higher chance of a recession, but we think the shape of the curve has more to do with expectations for falling inflation than with a slowdown in growth,” strategists wrote in a note on Thursday. “A look under the hood shows that real forward rates don’t reflect the high risk of a recession. Instead, they may show that people expect a softer landing than the consensus.”
The bank said this is because forward real yields, which show what the market expects bond yields to be after adjusting for inflation, have only seen a “modest drop” in the short term.
That means investors think the Federal Reserve will slowly lower interest rates, which they won’t do if the economy is at a high risk of going into a slump.
“Curve inversion at historically extreme levels does not currently indicate a higher risk of a recession. Instead, it is mostly due to expectations for cuts and inflation coming closer to the Fed’s 2% target,” strategists said, referring to the Fed’s goal for inflation.
Investors have been worried about a recession for the past year because the Fed has been raising interest rates quickly to stop inflation, which could push the economy into a recession.
Rates are now at their highest level since 2007, and Fed officials say that more increases are likely later this year. The markets think there is an 87% chance that the Fed will raise rates by another 25 basis points at their policy meeting in July. This would bring the target Fed funds rate up to 5.25-5.5%.
The New York Fed, on the other hand, thinks there is a 71% chance that the economy will go into recession by this time next year.