The economy is slowing, inflation is cooling, and the banking crisis is persistent. But the Federal Reserve was predetermined to hike interest rates on Wednesday. The die was cast.

However, certain “red flag” indicators could elicit a pause in tightening at the Fed’s next policy-making Federal Open Market Committee (FOMC) meeting, June 14-15. Below, I examine the recessionary signals that could compel the Fed to quit hiking rates next month.

The FOMC on Wednesday announced a rate hike of 0.25%, bringing the federal funds rate to a range of 5% to 5.25%, the highest level in 15 years. It was the 10th consecutive rate hike since March 2022.

No one was surprised. Heading into the announcement, futures traders were forecasting a nearly 90% chance that the Fed would hike rates by a quarter-point.

But it appears that the bond market may force the Fed’s hand into pausing its rate hikes. Inverted yield curves are the key.

The two-year and 10-year Treasury yield curve is heavily inverted (see chart):

The three-month versus two-year curve also is inverted. An inverted yield curve occurs when a yield curve graph of bonds inverts and the shorter-term bonds are offering a higher yield than the long-term bonds. An inverted yield curve is considered a leading indicator of recession.

A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds, because of risks associated with time.

Bond prices and yields move in opposite directions. An inverted yield curve is unusual; it reflects bond investors’ expectations for a decline in longer-term interest rates, typically associated with economic downturns.

As the economy slows because of higher interest rates, longer-term yields fall as demand for credit declines. Credit also becomes less available, as bank margins shrink. This dynamic means rate hikes lose their punch.

We’re witnessing other recessionary warning signs.

U.S. gross domestic product (GDP) slowed to 1.1% in the first quarter. Sectors that are particularly sensitive to interest rate increases, notably real estate, have slumped as the Fed’s rapid rate hikes take their toll. Corporate earnings and jobs growth are decelerating as well.

Banking turmoil has eased but remains with us, as evidenced by the government-orchestrated sale on Monday of insolvent First Republic Bank to JPMorgan Chase (NYSE: JPM). A major culprit for stress on the banking system is the Fed’s aggressive tightening.

However, for Wednesday’s decision, the appearance of “toughness” in the fight against inflation apparently superseded all else, even though it’s problematic just how effective rate hikes are in combating the structural inflation we’re seeing now. Interest rate policy, for example. doesn’t ameliorate supply chain disruptions caused by the Russia-Ukraine war.

In prepared remarks Wednesday, the FOMC stated: “With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.”

The Fed has not always been so forthright with its intentions. In fact, in the 1970s, the prevalent belief was that the Fed should be as vague as possible about its plan for interest rates.

Back then, investors yearned for scraps of data regarding the direction of interest rates. They would monitor the trading desk at the Federal Reserve Bank of New York for clues about the Fed’s purchase or sale of bonds, which would indicate its desire for higher or lower rates. Later in the 1980s, huge market swings would occur on days that certain money supply levels were reported, another harbinger of Fed action.

It was not until 1994 that the Fed publicly disclosed changes in its target for the federal funds rate. Five years later in 1999, the Fed added a future looking statement.

Even so, Jerome Powell’s three immediate predecessors, Janet Yellen, Ben Bernanke, and Alan Greenspan, tended to offer somewhat opaque commentary to give the board wiggle room when deciding what to do with rates.

By comparison, Powell is Chatty Cathy, which often unnerves investors. A recent study revealed that market volatility is three times higher during press conferences held by Powell than those that were held by his three predecessors.

During his press conference Wednesday afternoon, Powell notably said: “We’re closer to the end” of this tightening cycle than the beginning. In Fed-speak, that’s a (faint) hint of a pause in June, and it initially encouraged investors, driving stocks into the green.

But stocks reversed direction in the final 45 minutes of trading and closed in the red, after Powell responded to a reporter’s question by saying interest rate cuts are not in the Fed’s base case.

As I watched Powell on television rule out a rate cut, I instantaneously got this comment from my colleague and friend Dr. Joe Duarte on the messaging app Slack:

“No rate cuts he says, and the market tanks. Wow!! Why can’t he just say, I won’t talk about that stuff.”

Sure enough, the main U.S. stock market indices finished mostly lower Wednesday, in choppy trading, as follows:

• DJIA: -0.80%
• S&P 500: -0.70%
• NASDAQ: -0.46%
• Russell 2000: +0.41%

All 11 S&P 500 sectors turned negative. The benchmark 10-year Treasury yield dipped to 3.66%.

Read This Story: Awaiting The Next Big Catalyst

Despite Powell’s remarks Wednesday that we still have a way to go in the fight against inflation, deflationary trends further strengthen the rationale for a pause.

The consumer price index (CPI) in March came in at 5% on a year-over-year basis, the lowest level since 2021. The personal consumption expenditures (PCE) price index came in at 4.60% YoY, compared to 4.69% last month and 5.36% last year.

PCE, which is the Fed’s preferred inflation gauge, also took a month-over-month dip, to 4.2% in March from 5.1% in February and 5.4% in January.

On Wednesday, the U.S. crude oil benchmark, West Texas Intermediate (WTI), fell nearly 5% to about $68 per barrel, amid renewed fears of recession and energy demand destruction.

Nothing is certain; forecasting is a hazardous activity. But here’s what the bond and energy markets are trying to tell us: the odds of a recession just got a lot higher, which means the Fed is unlikely to raise interest rates again this year.

History shows that when the Fed quits hiking rates, stocks soar. But until then, brace yourself for a bumpy ride.

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John Persinos is the editorial director of Investing Daily.

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