‘Poker Face’: The Yield Curve Inverts As Investors Call The Fed’s Bluff
‘Poker Face’: The Yield Curve Inverts As Investors Call The Fed’s Bluff by Adem Tumerkan – Palisade Research
Last week when Jerome Powell – the Federal Reserve Chairman – said that we were now “just below” the neutral rate of interest, markets soared and bonds rallied.
In case you didn’t know – the ‘neutral rate’ is a term coined by 19th century economist Knut Wicksell. It’s the theoretical rate at which monetary policy is neither stimulating nor restrictingeconomic growth.
But now that Powell said that the neutral rate is lower than he previously indicated two months ago – this is a problem.
The market now believes that Fed tightening via rate hikes and Quantitative Tightening (QT) istoo tight. Meaning if they continue hiking, they will raise rates above the neutral rate – which will impede growth.
All this and more is why yesterday we saw a section of the yield curve – the 3-year and the 5-year spread – finally invert for the first time since the Great Recession of 2008.
This move shows us a big revelation. Which is: the bond market’s calling the Fed’s “booming economy” and “rising inflation” bluff. . .
I wrote about this a few months ago – back in May – that Wall Street (specifically bond investors) weren’t sold on the inflation and growth story that Trump and the Fed was pushing (read here).
What do I mean by this?
Simply put – optimism about global growth, the inflation rate rising, and the Fed hiking many more times was all supposed to push long term rates much higher. Specifically well above the psychologically important 3% 10-year U.S. Bond threshold.
But instead of long-term rates rising parallel with the Fed’s short-term rate hikes – they’ve actually collapsed.
This caused the yield curve to turn sideways (flat) – and now finally inverting.
If you open your eyes and ignore the Fed’s cheap ‘soaring economy’ chatter – things aren’t looking so good in the global economy.
Here are just a few things. . .
First – global growth is showing weakness.
For example – in October – China reported their weakest GDP (economic growth) numbers since 2009. Also – their on-shore bond defaults hit a record high amid liquidity problems (read more here).
World trade has also drastically declined over the last year.
And the European Union – even with their rampant monetary stimulus from the ECB (European Central Bank) – is suffering from slowing growth as well.
Second – global corporate earnings expectations have declined.
The strong-dollar has ravaged global companies alongside rising short-term interest rates – making it more expensive to service debts.