Bond market rebound is bad news for the economy: Gary Shilling

The good news is that yields in U.S. Treasury securities may be near their peak. The bad news is that makes the recession I’ve been forecasting since February more likely.

The current campaign by the Federal Reserve to raise its main policy interest rate -- the overnight federal funds rate -- in response to rapid inflation normally precipitates a business downturn. Since the central bank adopted this measure in 1954, there have been 11 recessions and only three exceptions, or soft landings — in 1966, 1984 and 1996. A soft landing occurs as the central bank lowers the funds rate after a series of increases with no recession unfolding. Until the Fed cuts rates, it’s uncertain as to whether its credit-tightening campaign is over or has merely paused.

My analysis of post-World War II history reveals that a 100-basis-point rise in the funds rate is linked to a 36-basis-point rise in the 10-year Treasury note yield and a 24-basis-point increase in the 30-year Treasury bond yield. The further out on the yield curve, the less the influence of central bank policy.

The 10-year note yield peaked at 3.48 per cent on June 14, the highest since 2011. It has since fallen back to around 3.22 per cent. The yield jumped from 2.18 per cent on March 16, when the Fed first raised its reference rate from a range of zero to 0.25 per cent to a range of 0.25 per cent to 0.5 per cent (it’s now in a range of 1.5 per cent to 1.75 per cent). The 1.30-percentage-point jump in the 10-year yield implies a 3.5-percentage point rise in the funds rate, which would bring it close to 4 per cent. That’s high enough to kill the economic expansion that has been floating on a sea of readily-available and cheap credit.