Stocktake: Investors brace for big rate hike

US recession talk is growing louder in financial markets. With inflation running at 40-year highs, investors are nervously awaiting next week’s Federal Reserve meeting. A rate hike of at least 75 basis points is a given, with markets increasingly open to the prospect of an increase of a full percentage point.

Rate hikes of this magnitude are economically damaging, but the inflation data is so bad that the opportunity for a “softish landing has passed”, warns Goldman Sachs, adding the Fed’s best hope now is “inducing a recession as soon as possible”.

Not everyone is so grave. Still, looking at two- and 10-year bond yields shows the yield curve is now more inverted than at any time since 2000. Yield curve inversions, when short-term yields rise above their long-term counterparts, are seen by many as the best indicator of a looming recession.

Optimists might note the three-month/10-year yield curve, which the Federal Reserve regards as a more reliable recession indicator, has not yet inverted. However, while this spread remains positively sloped, it is flattening at a rare and alarming rate.

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The flattening seen over the past four weeks is at levels unseen since the global financial crisis, says Bespoke Investment. Historically, these kind of moves “don’t happen very often”.

Little wonder, then, that all eyes will be on Fed chief Jerome Powell next week, as markets brace for potentially the biggest rate hike in decades.