The FOMC has just cut rates, and all eyes are on the yield curves. While the media focuses on the 10-year/2-year curve, it’s the 10-year/3-month curve that could be the real recession predictor. Are we on the verge of a soft landing, or is the market’s optimism masking deeper risks? Join me as we explore what these signals mean for the economy—and your portfolio.

FOMC’s Latest Rate Cut: What Comes Next for the Economy?

The Federal Open Market Committee (FOMC) has just cut rates by 50 basis points (bps), as many expected. But now the real question looms: what does this mean for the economy and markets going forward?

Yield Curves and Recessions: What You Need to Know

Recently, there’s been a lot of buzz about the 10-year minus 2-year yield curve (purple line) steepening from inverted to normal at 9 bps. This shift has led some to believe that the Fed has successfully engineered the elusive soft landing. In my view, this recent steepening of the yield curve is one reason the S&P 500 financial services sector has performed so well. Typically lending institutions favor a steeper yield curve.

But let's dig deeper into the data. The chart above compares two key yield curves to forward-looking recession probabilities (pink line). Historically, the deeper the inversion of the 10-year minus 3-month Treasury yield curve, the higher the likelihood of a recession 12 months out. Despite the steepening of the 10-year/2-year curve, recession probabilities have not declined. Typically, recession risks don’t start to fade until after the 10-year/3-month curve steepens significantly.

Why Focus on the 10-Year/3-Month Curve?

While the news often zeroes in on the 10-year/2-year curve, I’m focusing on the 10-year minus 3-month yield curve (orange line). Why? Because it’s historically been a more reliable indicator of recession probabilities, according to most academic research, including the New York Fed's Recession Probability Model.

Right now, the 10-year/3-month curve remains deeply inverted at -114 bps. Historically, when the Effective Federal Funds rate (blue line) starts to move lower, it signals that the 10-year/3-month curve is on the path to normalization. This is because the FOMC directly influences the front end of the curve, in this case 3-month treasury yields. An indication that the FOMC will be lowering rates, will push 3 months yields lower. Based on current conditions, we should expect this curve to begin normalizing following the FOMC’s initial rate cut.

Why This Matters: History as a Guide

The Federal Reserve Bank of New York recession model is one of the most reliable recession indicators we utilize. But many investors are rushing to declare, “This time is different,” cheering that the Fed has achieved the soft landing we all hoped for.

The reality is that recession probabilities actually just peaked in May 2024 at 70.85%—the highest level in over 40 years. Even now, recession probabilities remain elevated at 61.79% looking forward to July 2025. Remember, this is based on the yield curve 12 months earlier. This data suggests that we can hardly put the concerns about a recession behind us. In fact, Jeff Gundlach came out recently citing that September of 2024 will be recognized as the begging of the recession (Fed rate cuts are arriving too late and layoffs show the US economy is already in a recession, bond king Jeff Gundlach says).

I’ve zoomed in on the last three periods of 10-year/3-month curve inversions: the Dot Com Bubble, the Great Financial Crisis, and the Pandemic. In all three cases, the curve normalized first, and then was followed by a recession and a subsequent market decline.



What’s more intriguing is that during the Great Financial Crisis and the Pandemic, the S&P 500 was still making new highs as recession probabilities peaked and the yield curve normalized. This is very similar to what we are currently experiencing today. The S&P500 is close to all-time highs as rates are starting to decline and the Yield curves are beginning to normalize.

Even during the Dot Com Bubble burst, while the market had already started to decline, there was still significant downside over the following years. The bottoms did not occur until well after the curve steepened into positive spreads.

Timing the Market: The Reality Check

As we’ve seen, timing the market with this indicator is incredibly difficult. Even with elevated recession probabilities, the broader market can continue to post gains. The point of this article isn’t to incite fear—it’s to provide a reality check.

We are going to dive deeper into some actionable ideas next week, but for now it is prudent to ensure you are comfortable with your current level of equity exposure. Ask yourself if you can tolerate a 10%, 15%, 20% or more decline in your equity positions. Now, do the math on how this would impact you from a dollar perspective. Write it down on a piece of paper. Look at it for a few minutes. Think about what this dollar amount means to you. Remember, it can take years for markets to recover (The Long Road to Recovery: Lessons from Historic Market Declines).

Will this amount of loss result in meaningful life changes? Will a loss of this amount result in you having to make life decisions differently? Would your kids need to go to a new school if you lost this amount? Would you have to put off retirement? Would you have to delay that new home purchase?

If the answer is yes, please consider allocation shifts to your portfolio so that the potential losses may not have such a significant impact. Remember, the more concentrated and less diversified your portfolio is, the greater these potential losses can be.

Most professional portfolio managers focus on the downside risk. If we manage the downside, the upside can take care of itself.

While many are quick to say this time is different, it may actually be unfolding in a similar fashion to past recessions. To truly say this time is different, we would need to see the 10-year/3-month curve normalize without a recession occurring in the next 18 to 24 months. Until then, history suggests otherwise.

“History doesn’t repeat, but it certainly rhymes.”

What’s Next?

In the coming posts, we’ll dig deeper into how markets typically respond to yield curve steepening. We’ll explore where opportunities have historically emerged and where they might lie today. Please be sure to reach email me if you need any help evaluating your equity exposure risk.