July 2019 Yield Curve Update

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Includes: FLAT, STPP
by: Kevin A. Erdmann
Summary

The yield curve has taken a sudden turn for the worse.

The Fed's tradition of using interest rates to convey their monetary stance is such a constant source of confusion.

The conversation about yields so often seems to hinge on the idea that the central bank is in full control of interest rates and uses them to make it more or less profitable to borrow and invest.

The yield curve has taken a sudden turn for the worse.

The Fed's tradition of using interest rates to convey their monetary stance is such a constant source of confusion. The conversation about yields so often seems to hinge on the idea that the central bank is in full control of interest rates and uses them to make it more or less profitable to borrow and invest. It baffles me how ubiquitous this sort of idea is in both professional finance and economics.

Recent movements in yields are a great case in point. It is common to hear this shift described in terms of expectations about Fed rate cuts. But the whole yield curve shifted down. This is not a sign that the Fed will be loosening monetary policy more aggressively. This is a sign that they won't be loosening aggressively enough. The neutral rate just changed, leaving the Fed behind as a victim of institutional inertia. That is in contrast to recent times when yields did react to clear signals from the Fed that it was going to be more aggressive. In those cases, short-term rates fell and long-term rates increased.

I only update my graph of the adjusted yield curve inversion monthly, so the red dot for July is at about the same spot as it was at the end of June. Of course, the 10-year rate has dropped 25bp since then. So, unless some sort of economic or political development greatly improves economic prospects in spite of a tight monetary posture, raising 10-year yields back up, then we are already at a point where, even with short-term rates at zero, the yield curve will be effectively inverted. This will likely lead to complaints about how the Fed is using QE4 to keep long-term interest rates low to boost investment and asset prices, including from many otherwise sensible people who are generously paid to manage other people's assets.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.