Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Support MFO
Donate through PayPal
Morningstar Article: The U.S. Treasury Yield-Curve Recession Indicator Is Flashing Red
OK, I understand the suggestions implied by the historical yield cure inversions. But were any of those historical inversions preceded by four or five years of extremely low interest rates (approaching zero) during a period of pretty decent growth?
Isn't it possible that the present inversion could simply be predicting a return to that low interest rate environment rather than a full-fledged recession?
Please understand that I have absolutely no background or pretensions to take a side in all of this. My question is an honest one, hoping to prompt am expanded discussion by those of you who are qualified to do that.
Isn't it possible that the present inversion could simply be predicting a return to that low interest rate environment rather than a full-fledged recession?
It absolutely could. Finance is not a hard science with mathematically measurable and repeatable outcomes that are always the same. But there is a logic to the recession explanation here. The Fed doesn’t normally lower rates unless it’s to stimulate the economy, to make borrowing cheaper, so more people and businesses will buy more stuff, so companies will need to produce more stuff and hire more workers to produce that stuff. The Fed doesn’t normally want to stimulate the economy by lowering rates unless we’re in an recession. The fact that long-term bonds have lower yields than short indicates that investors believe—a key word here—that the Fed rate hikes will not last. So they are locking in long-term yields that are still better than they were a year ago with the expectation that we will enter a recession, the Fed will cut rates and those long-term Treasury bonds will rally. Bond prices move inversely with rates.
But that lower long-term bond yield just indicates investors’ belief in what will happen. Investors can be wrong. But bear in mind who these investors are. The largest owners of long-term Treasuries are the wealthiest most powerful institutional investors on the planet. The inverted yield curve is saying they think we’re headed for a recession instead of a soft landing. Yet I can’t imagine the Fed will cut rates again unless we are in a recession. Rate cuts are a tool to stimulate consumption. Why use it unless you need it? But another alternative is if we have a soft landing is the Fed doesn’t cut rates but long-term bond yields go back up as investors sell long bonds to buy other assets such as stocks.
And from that Schwab article: "the futures markets are now pricing in a rise in the federal funds rate to the 5% to 5.25% region in the second quarter of 2023, with the rate staying above 5% until late 2023."
That was the terminal rate that we have been discussing here. Holding on CDs or treasuries with yields near that rates would be good for next several years. Don’ want to hold bond funds until the Fed starts to cut interest rates. My guess would be the latter half of 2023 unless the recession gets really bad and inflation reaches a level the Fed is comfortable with. The 2% target is not realistic today.
My guess is final range of 3-4.5%. That would allow Fed nice range of "dry powder" to decrease rates if necessary to offset future financial problems. What the Fed says and what it really thinks may be two slightly different things. I doubt that Bernanke's demonstration of Fed weaponry will be forgotten any time soon.
Your guess on the inflation range is very reasonable. Except for Bullard (hawkish guy), a number of Fed members want to take a more gradual rate hike, i.e. 50 bps in December, and perhaps several 25 bps hikes in first half of 2023. I think US is entering a recession late this year. Hopefully the people are in better financial situation and with debt comparing to 2008. By then I hope the Fed can start to cut the rate again.
Also the Fed has stop buying bonds (quantitative tightening) and may sell the bonds on the book. How would this would impact the bond market?
The St Louis Fed President Bullard came out with his out-of-the-box 7% rate. But he is rotating off as a voting FOMC member in December 2022 and just wants to go out with a big bang. In 2023, he will be replaced (as voting FOMC member) by Dallas Fed President Lorie Logan. She is more dovish than hawkish Bullard.
Good to know. Bullard caused a stir in the market as he was pushing aggressively.
Some of the data take longer time to work themselves through the inflation calculation, so the reported CPI may be sticky or lagging the actual data being presented. Thus this may suggested inflation may has peaked. Think Paul Krugman or the other professor made that statement.
My guess is final range of 3-4.5%. That would allow Fed nice range of "dry powder" to decrease rates if necessary to offset future financial problems. What the Fed says and what it really thinks may be two slightly different things. I doubt that Bernanke's demonstration of Fed weaponry will be forgotten any time soon.
There's also a difference between any current rate during a hiking cycle and the rate that will result after the hikes have worked their way through the economy, which can take many months. So they've got the fallback of "yeah, it's down only to 4% now, but we're confident that once all our work is reflected in the system, it'll be more like 2%."
And if they actually did wait to stop until year-over-year was at 2%, the biggest risk would be a truly awful, long recession rather than a shorter, shallower one.
Comments
From my March, 2019 post regarding yield curve perspective from Campbell Harvey, Duke University, which includes several study links.
The YIELD-CURVE is mostly inverted (2y-10y, 3m-30y, etc) but what really matters is the short end that Powell is watching, 3m-18m and/or 3m-3m18mforward spread; these are unusual spreads but close is the readily available 3m-2y spread that didn't invert yet.
https://stockcharts.com/h-sc/ui?s=$UST2Y-$UST3M&p=D&yr=1&mn=0&dy=0&id=p26635956684
Isn't it possible that the present inversion could simply be predicting a return to that low interest rate environment rather than a full-fledged recession?
Please understand that I have absolutely no background or pretensions to take a side in all of this. My question is an honest one, hoping to prompt am expanded discussion by those of you who are qualified to do that.
But that lower long-term bond yield just indicates investors’ belief in what will happen. Investors can be wrong. But bear in mind who these investors are. The largest owners of long-term Treasuries are the wealthiest most powerful institutional investors on the planet. The inverted yield curve is saying they think we’re headed for a recession instead of a soft landing. Yet I can’t imagine the Fed will cut rates again unless we are in a recession. Rate cuts are a tool to stimulate consumption. Why use it unless you need it? But another alternative is if we have a soft landing is the Fed doesn’t cut rates but long-term bond yields go back up as investors sell long bonds to buy other assets such as stocks.
https://schwabassetmanagement.com/content/market-perspective?render=print
"the futures markets are now pricing in a rise in the federal funds rate to the 5% to 5.25% region in the second quarter of 2023, with the rate staying above 5% until late 2023."
That would be my guess, too.
My guess is final range of 3-4.5%. That would allow Fed nice range of "dry powder" to decrease rates if necessary to offset future financial problems. What the Fed says and what it really thinks may be two slightly different things. I doubt that Bernanke's demonstration of Fed weaponry will be forgotten any time soon.
Also the Fed has stop buying bonds (quantitative tightening) and may sell the bonds on the book. How would this would impact the bond market?
Some of the data take longer time to work themselves through the inflation calculation, so the reported CPI may be sticky or lagging the actual data being presented. Thus this may suggested inflation may has peaked. Think Paul Krugman or the other professor made that statement.
And if they actually did wait to stop until year-over-year was at 2%, the biggest risk would be a truly awful, long recession rather than a shorter, shallower one.