The near-term forward spread turns negative for the first time since March 2008

For traders and investors, it is about looking for the most accurate and the most telling indicators that something will happen in financial markets. When it comes to a recession or the Fed easing policies, the most often looked at measure is the inversion of the Treasury yield curve.

But for some, they look for other indicators and the near-term forward spread is one of them. This is the spread between the forward rate implied by Treasury bills six quarters from now and the current three-month yield. If the spread falls below zero, it supposedly indicates that market participants see easing policies to follow by the Fed and a recession could be coming in the "next several quarters".

One of the reasons why market participants are keeping an eye on this measure is that because the Fed is also looking at it, as noted in its research paper back in June 2018 here. At the same time, the Fed acknowledged looking into this measure as an indicator of the likelihood of a recession. This was the excerpt of the Fed minutes released in July for its June FOMC meeting:

Participants also discussed a staff presentation of an indicator of the likelihood of recession based on the spread between the current level of the federal funds rate and the expected federal funds rate several quarters ahead derived from futures market prices. The staff noted that this measure may be less affected by many of the factors that have contributed to the flattening of the yield curve, such as depressed term premiums at longer horizons. Several participants cautioned that yield curve movements should be interpreted within the broader context of financial conditions and the outlook, and would be only one among many considerations in forming an assessment of appropriate policy.

Now that the indicator has crossed over to negative. What does this mean for future Fed policy?

Much like the inverted yield curve, the Fed is expected to take into account these measures and expectations to derive their next steps. But I wouldn't expect a drastic change in policy to materialise just because of this "alarm bell" being rung.

However, Fed economists did also acknowledge that this gauge has a more predictive power of a recession than say the 2s-10s spread. But as mentioned above, beauty lies in the eyes of the beholder.

At the end of the day, the dollar and markets will only move if what they believe is the key indicator is the one sending the signal. As far as I can tell, the 2s-10s spread remains one of the most watched in that regard. Currently, that sits at 16 bps as of today but should be headed towards a negative figure in the coming quarters.

The Fed isn't going to turn full-on dovish just because something like this occurs. They're expected to be steadfast and keep with the current communique and if anything, slowly guide markets towards where they see rates potentially heading.

That said, money markets are pricing in zero Fed rate hikes this year. So, there isn't much further setback to be experienced by the dollar in terms of markets scaling back their expectations. The real fear for dollar bulls will be when markets start believing that the Fed will move towards cutting rates as a recession is coming. But I reckon that will require some form of communication by the Fed before happening.

As for the near-term forward spread, you can read more on that by Bloomberg here.