The Fed's preferred recession indicator shows traders want the central bank to ease off rate hikes

• The difference between the current rate on the three-month Treasury bill and expectations for it in 18 months is the Fed's preferred recession indicator.
• That spread has fallen 95 basis points so far in July, the largest monthly drop since data on it started in 1996.

An important recession indicator for the Fed is flashing a warning, sounding an alarm that traders want the central bank to ease off rate hikes.

The bond market's three-month bill premium, which measures the spread between the yield on three-month Treasury bills now and 18 months in the future, has plummeted 95 percentage points so far this month. That's the largest monthly drop since data on it started in 1996, according to Bloomberg.

It's an ominous sign for Fed Chairman Jerome Powell, who has previously used the spread as a rationale for hiking interest rates to stamp out inflation.

In March, the central bank even published a study on the reliability of the three-month bill premium as a barometer for inflation expectations, as opposed more widely cited bond market indicators like the spread between the two-year and 10-year bond yields.

But with the three-month bill premium sinking, it's also at risk of inverting – a double warning on the economy, given that the yield curve on two-year and 10-year bonds has already inverted several times this year and deepened its inversion since mid-June.

But the Fed has shown no signs of easing off on its fight to tame inflation and is continuing hiking rates with another 75-basis-point increase expected on Wednesday.