ES #141: Fed Spreads & Recession

Energy Shots #141

After backing every rate decision since March 2022 with data-centric takes on a two-part mandate of “stable prices and maximum employment”, Fed governors have pivoted to a new argument that cites expectations for higher inflation and unemployment after the Trump administration’s tariffs.

As a result, one-hundred and sixty-eight days have passed since the Federal Reserve’s last rate cut—longer than every other inter-cut pause in the 1999-present record (100th percentile, 1999-2025)—despite slower U.S. payroll growth and consecutive prints of promising inflation data.

Indeed, a closer look at market yields on US 2YR Treasuries shows participants do not share the same outlook as the Fed’s more ‘qualitative’ prediction method.

The spread between the effective federal funds rate and the market yield on US 2YR Treasuries averaged over 47 basis points below the FFR for the last two months, signaling participants’ growing concerns that the Fed will emerge substantially behind the curve.

As shown below, Friday’s 41 bps spread between the Fed’s policy rate and the market yield on 2YR USTs ranks at the 86th percentile for all days since January 1, 1999—a level that has preceded all three recessions in the 1999-2025 period.

While EFF futures positioning indicates median expectations have fallen to just two 25 bps moves this year in response to Chair Powell’s “hawkish” commentary, the spread between current 2YR yields and the effective fed funds futures rate (433 bps) points to higher odds for an upside surprise, including a potential forced cut before the end of the year.

The Federal Reserve’s June 17/18 meeting could provide this surprise. However, members’ latest anecdotal commentary indicates the group’s record 168-day hold has room to grow.

See you next Sunday.

ES.

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