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HomeNewsFed keeps wary eye on yield curve while signaling hikes on track

Fed keeps wary eye on yield curve while signaling hikes on track


Inversion of a key part of the yield curve has caught the attention of some at the Federal Reserve, but officials show no sign of ditching plans to keep raising interest rates to get inflation under control.

The U.S. two-year yield briefly exceeded the 10-year on Tuesday for the first time since 2019, inverting yet another segment of the Treasury curve and reinforcing the view that rate hikes may cause a recession. The spread later went back to being slightly positive on Tuesday and remained so on Wednesday.

Short-term yields rising above those with a longer term are traditionally seen as a recession warning. The idea is that the front end of the yield curve moves up as the Fed hikes rates, but yields further out fall as investors bet the tightening will slow growth by too much and force the central bank to reverse course and cut.

“I continue to believe the yield curve gives us useful feedback about where the path of policy is relative to neutral,” Minneapolis Fed President Neel Kashkari tweeted, referring to a 2018 essay he penned highlighting its qualities as an early harbinger of recession.

Officials lifted interest rates off zero this month and signaled a series of increases that would raise them to 1.9% by the end of the year and 2.8% in 2023. They estimate the neutral rate, the theoretical level that neither speeds up nor slows down activity, at 2.4%. 

Officials — from the hawkish wing of the U.S. central bank to its doves — have stated their determination to raise rates to cool the hottest inflation in 40 years. Several have declared they are open to hiking by a half point at their May 3-4 meeting, which Chair Jerome Powell also said that was on the table if necessary.

“Overall, yield curves plural are not signaling imminent recession risk and we should not expect them to deter the Fed from initiating two or three 50 basis point moves,” wrote Evercore ISI’s Krishna Guha and Peter Williams in a note to clients. “However, it is very plausible that yield curves collectively could deliver a stronger recession risk signal at some point next year, which would contribute to an eventual Fed pivot to cut rates again.”

Other policy makers have stressed the economy’s ability to handle higher borrowing costs and voiced confidence in their ability to achieve a soft landing that lowers inflation back toward their 2% target while avoiding a recession, no matter what warnings are flashed by the bond market. 

That doesn’t mean they aren’t paying attention.

Kansas City Fed chief Esther George, who favors “expeditiously” raising rates to neutral, said she was concerned by the curve’s inversion — not because it signals a recession — but because of what it could foreshadow about risk-taking and the strength of lenders, particularly community banks.

“An inverted curve has implications for financial stability with incentives for reach-for-yield behavior,” George said on Wednesday. “An inverted yield curve also pressures traditional bank lending models that rely on net interest margins, or the spread between borrowing short and lending long.”

Powell himself played down the peril heralded by the flatness of the yield curve by pointing to a different measure — the spread between the current three-month Treasury bill rate and bets on where that will be in 18 months — which has steepened sharply.

Atlanta Fed chief Raphael Bostic also sounded relaxed, noting that longer-term yields had been depressed by decades of ultra-low inflation as well as safe-haven demand from investors following Russia’s invasion of Ukraine.

“I’m going to look at the shorter end of the curve because that’s the part that we control directly,” he told an audience in Los Angeles late on Tuesday. “It is definitely something that we will need to look at but it is not the only thing that we will look at.”

 

This story has been published from a wire agency feed without modifications to the text. Only the headline has been changed.



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