Achtung baby

The market is awaiting a potential agreement between democrats and republicans to avert the government shutdown on Tuesday, which if not reached, will affect the publication of the employment report and the inflation report due in the first 2 weeks of October. In the meantime, the bond market, particularly the treasury market, may be revealing its view of the U.S. economic landscape. In the chart below, you can see 2 lines: the red one is the 3 Month treasury bill rate, which is adjusting lower, reflecting the view that the Fed will continue to cut in October. The black line shows the hiked curve slope, calculated by subtracting the 3 month rate from thr 10 year Treasury bond yield. The yield curve is basically flat, and comes from an extended period of inversion, but when you combine both lines, you can see a pattern: when the short rate (red line) decreases and the slope (black line) increases, a recessions occurs. In the chart recessions are marked by the gray areas. If Fed funds are indeed cut, with the aggressiveness that the White House expects, we could see a steepening of the yield curve as inflation expectations rise, and that may cause, or simply coincide with, a recession. It is difficult to see a recession coming after a strong revision upwards of the 2Q GDP, but it can happen, as the deficit continues to widen and the cost of debt rises. Gold keeps signaling something is not right. Will other indicators start flashing red?

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