Money markets priced for a recession

Conditions in money markets have been easing over the last few weeks with the TED spread (the difference between the interest rates on interbank loans and short-term US government debt) now down to 203 basis points.

In Australia the gap between the 90-day bank bill rate and overnight interest rate swap spread was down to 48 bps, as of Friday. Even the RBA has been pumping less money into the system, with the result that exchange settlement account balances have dropped to around half of the $11.2 billion peak on October 20.

But one indicator that has largely escaped comment is the spread between the 90-day bill rate and the official cash rate - the spread has been consistently negative since mid October.

And while this can be dismissed, with the observation that the bank bill market is simply pricing in further cuts in the official cash rate, the spread has only being negative in the past in times of recession or recession-like conditions.   

The spread between the 90-day bank bill rate and the official cash rate was negative before the start of the 1990s and stayed that way until mid 1992. It went negative again for most of the period from mid 1996 to mid 1998; it was negative for nearly all of 2001 and apart from a blip in mid 2003, hasn't been negative until now.

No doubt further interest rate cuts are coming, with the Bank of England being the latest to move on Thursday and making the largest cut among the major central banks at 1.5 per cent to 3.0 per cent. Needless to say, this frightened many in the market.