The maximum inversion in the yield curve is between the Fed Funds (FF) Rate and the 3-year note: about 62 basis points or if you prefer 0.62 percentage points.

If only the low end moved (but it won't), the Fed would have to cut rate by at least 62 basis points to kill all the inversions.

Not that Simple

It's not quite that simple because the yield curve is a moving target that's unlikely to react only at the low end.

Assume the effective FF rate moved to 1.91 from 2.41 on a 50 basis point (half a percentage point) cut.

That's a very good assumption. But, the middle or long end of the curve might respond either more or less than the rate cut.

If the market thought more rate cuts were coming, the 5-year yield could easily dive by 75 basis points from 1.816 to 1.066.

The Fed Funds to 5-Year inversion would be 0.75 percentage points, greater than the current 0.594 percentage points currently!

That is not a prediction, it is simply a what if.

At the other extreme, the market could react as if the Fed saved the day and recession was averted. In that scenario, the yield on the long end would soar and the yield curve would steepen across the board.

What's Likely?

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I suspect the most likely thing is something close to an equal reaction through the middle portion of the curve with a bit to somewhat less at the far end.

If so, the yield curve will be flatter (less inverted starting with the FF rate), but the spread between the FF rate and the 5-year bond (the middle portion of the curve) won't move all that much.

Shock and Awe Needed

Simply put, a half-point cut will not un-invert the yield curve and the maximum inversion amount will hardly change at all.

If the goal is to steepen the curve, the Fed may need to shock everyone with a full percentage point cut.

Would that Save the Day?

My answer is no.

Un-inverting the yield curve is easier said than done. And it won't matter anyway.

A recession is already baked in the cake.

By the way, I am not arguing for a full point rate cut. Rather, I suggest it will not do a bit of good.

For discussion of these dynamics and the need for a big rate cut, please see Fed's Asymmetric Bubble-Blowing Policy in Pictures.

Mike "Mish" Shedlock

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