Macro Observations

I’ve warned about the potential risks that are looming if credit spreads finally blow out (the “credit event”) and how that could cascade into significant declines for risk asset prices. So far, that hasn’t happened. That could also mean that a recession will be delayed as well. Or does it? The last time that the Fed kicked off a rate cutting cycle with a half point move was 2007. Can 2007 tell us anything about what to expect? How closely does 2007 compare to 2024? It turns out, more than you think!

Ever since the Fed announced it was cutting interest rates by 50 basis points last week, the markets have been in a pretty good mood. Treasury yields rising could be a sign that investors feel good about the soft landing narrative, they’re rotating back out of bonds and into stocks or, more likely, both. Except that things just got more complicated this week. China finally dropped a stimulus bomb on its flailing economy.

The TED spread mostly did a good job of signaling stress in the markets - 1987, 1990, the tech bubble, the financial crisis and the COVID pandemic. Over the past year, however, we can see that this spread hasn’t moved much at all. In other words, it hasn’t been signaling much credit risk at all. If the original TED spread is still low and credit spreads are low, is there any ratio out there that actually is signaling growing risks in the credit market? Turns out there is.