The same experts who repeatedly assured us that subprime was “contained” before the Financial Crisis now seem certain that an inverted yield curve is a broken signal that won’t lead to a recession this time, as it has every time in the last 50 years. It is apparent that intellectual humility is not passed out along with doctorates in economics.
Are They Really Sure the Yield Curve is “Contained?”
The current Fed Funds rate target is 1.00% – 1.25%, and an increase to 1.50% is widely expected in December. The Fed also projects 75 additional basis points of tightening in 2018, which would bring the Fed Funds rate to 2.25%, while the 10 year Treasury currently yields 2.32%. So they are being pretty cavalier about causing a potential inversion. While the 10 year yield may increase in the next 6 months, that remains to be seen. But there seems to be no caution or conditions being placed on the tightening schedule. This seems rather foolish as inflation has not yet shown itself, and average employees are still waiting to see some decent wage growth in this weak recovery. It would seem enormously naive and reckless to simply assume clairvoyance on the part of the experts and completely ignore the historical reliability of the recession warning that an inverted yield curve provides.
“Every recession in the United States — and accompanying global economic recession over the past 50 years — was preceded by an inverted yield curve. The yield curve inversion usually takes place about 12 months before the start of the recession, but the lead time ranges from about five to 16 months. The peak in the stock market comes around the time of the yield curve inversion, ahead of the recession and accompanying downturn in corporate profits.”
— Jeffrey Kleintop
Hippocrates Would Counsel Caution
Why not pause Fed Funds hikes at say 1.75% and speed up the sell off of the Fed balance sheet if they don’t get the steepening of the yield curve that they want and expect? And if this accelerated sell off of Treasuries doesn’t get the market response they want, then shouldn’t they assume that the market is telling them the economy can’t take it and will likely succumb to recession if they proceed with tightening?
A little caution would seem appropriate in the absence of actual signs of inflation. Such a hard won and meager recovery shouldn’t be just thrown away before the little guy has participated through decent wage growth. Isn’t it just as likely that the Philips Curve model is flawed if not broken? With all of the wailing about the output gap since the Financial Crisis, I wouldn’t think they’d want to chance making it worse unnecessarily.
Better to make sure inflation is a clear and present danger before risking a recession. We can’t afford another misguided and premature tightening like the one in 1937 that caused the recession within the Depression. Remember: First, do no harm.
“Humility means loving the truth more than oneself.”
— Andre Comte-Sponville
“The conventional view serves to protect us from the painful job of thinking.”
— John Kenneth Galbraith
“There are all kinds of businesses that I don’t understand, but that doesn’t cause me to stay up at night. It just means I go on to the next one, and that’s what the individual investor should do.”
— Warren Buffett