What “should” have happened last month to the Treasury curve did not. The Federal Reserve, as you know, is in a race with itself to fulfill what are almost certainly politically-driven directives. From the White House through the Halls of Congress, the need for someone somewhere to appear to be doing something about “inflation.”
Since that job is, by law, for the Fed what we’re getting is rate hikes. The FOMC, the central bank’s policymaking body, voted last month for a single quarter-point increase to its federal funds range. More increases are on the way, likely to be at double the change.
That’s not all. Having increased its own balance sheet after more than two years of exceptionally large asset purchases, known colloquially as quantitative easing, the FOMC already stopped its increase and now intends to begin decreasing perhaps as early as next month.
Just how these moves might arrest the accelerating CPI is actually anyone’s guess. There is no science here; on the contrary, not only is the Federal Reserve being forced to act politically, there is not now, nor has there been, any correlation whatsoever between its policies and consumer prices (let alone conditions in the wider economy).
For one thing, nothing the FOMC will do today or tomorrow is going to get more oil up from out of the ground; either here in the United States or from anywhere else around the world.
Gasoline prices, in particular, are the forefront of what the public considers to be inflationary excesses when the actual economic case is one of a non-monetary supply shock. There are, therefore, two ways to end the price pain.
The first is greater supply; basic economics. The second is an old expression: the solution to high prices is … high prices.
Eventually, paying more and getting less leads to all manner of big economic problems where consumers just stop buying; and not only what goods or services have become relatively more expensive. This scenario of what’s called demand destruction isn’t theory, nor is it some far distant worry.
It is visible right now all around the world, from Europe to China and all those multitudes of the world’s people in between. The supply shock spiking oil and other goods prices is not an American problem alone (a key clue how the Fed isn’t really involved here).
The yield curve has therefore flattened dramatically.
A flat yield curve is one where the spreads or differences in yields between those longer-dated Treasuries and others of shorter maturities diminish. Smaller calendar spreads like these indicate concern and a higher perceived (by the market) potential for future economic and financial trouble; a growing appetite in this huge, sophisticated market to hedge (in various ways) against a more likely and more widely-accepted risky scenario(s).
Continuing on, eventually the curve inverted (that is, longer-dated Treasuries yielded less than those of shorter maturities, completely upending what’s typically normal and healthy in the upward slope of the curve). What most of the public knows is that yield inversion, particularly the spread between the 2-year and 10-year, is historically associated with recession.
Since April 1, however, the yield curve is, mostly, un-inverted again. Longer-run spreads are back above their shorter counterparts currently. Recession risk canceled?
In the year 2000, just prior to what became 2001’s dot-com recession, back-end inversion had arisen in late 1999, deepened in January 2000, and then “bad” steepening shortly thereafter which would continue throughout the rest of that year even though the FOMC at the time under Alan Greenspan would continue to hike rates until mid-May!
Those at the Fed never pay the curve any heed; not then, not now.
What all this means is relatively simple; inversion isn’t the “thing” to worry about, rather it’s when inversion disappears if only to get replaced by the bad form of steepening (the “good” form would be if longer yields continue to rise and do so more than shorter yields, each keeps going along with the FOMC’s projections into the future; I should point out, this never happens which is why whenever inversion shows up even the public knows to look out).
The end of our “inflation” still projects to be very different from the politics.