📝FFR/10-Year Spread Better Predictor Of Fed Pivots: Wells Fargo

Recently, our preferred 10-year/1-year Treasury yield spread breached the recession prediction threshold in August and remained negative through November, suggesting there is a 91% chance of a recession during the next 12 months.

The fed funds rate/10-year threshold breached back in March 2022, suggesting a recession and/or a Fed pivot is in the near term picture. It is worth mentioning that since 1955 (the starting date of our analysis), every threshold breaching has been associated with a recession and accompanying change in monetary policy.

Utilizing the 10-year/1-year spread as our predictor for monetary policy pivots, the spread was unable to provide any signal about the FOMC's policy changes in the 1980s and 1990s. In 2019, the spread turned negative in August of that year, immediately following the FOMC's decision to begin cutting rates at the end of July.

We now put the fed funds rate/10-year Treasury yield threshold in the driver's seat. The threshold predicted all the FOMC pivots in our analysis. Notably, the Fed policy changes during the 1960s, 1980s and 1990s were predicted in back-testing, but the 2019 prediction was in real time.

We expect the dramatic rise in rates will hit demand in the back half of 2023 with a recession starting in Q3-2023. That said, we do not expect the Fed to cut rates immediately at the first sign of weakness. Specifically, we expect the Committee to stay on hold for the rest of 2023, and we look for the first rate cut in Q1-2024.

-Wells Fargo