Aligning our Thoughts on the Yield Curve
Everyone is gabbing about the inverted yield curve and the Fed’s resolve to raise rates until inflation is crushed like a bug. And while that’s the message, the bond market might have some thoughts on the subject. Here are the approximate yields for Treasuries as of this note
(September 13th, 2022):[1] 2yr: 3.7% 5yr: 3.5% 10yr: 3.4% 30yr: 3.5% Many feel that these different maturities convey similar information but in my view they don’t. From a basic standpoint, a bond’s yield represents a combination of inflation expectations and economic growth expectations. We can view a near term (under three years) bond’s yield as being devised mostly from nearer term inflation expectations. Conversely, the yields of longer-term bonds are mostly a projection of longer-term economic growth rates. Right now, politicians are arguing about whether or not we are in a recession. The basic fact is that GDP grew at 5.7% or so in 2021 and will likely grow at around 1% for 2022 (maybe). That is a dramatically negative rate of change, and I think it will begin to be seen in the longer-term treasury rates. As such, the technical definition of a recession is somewhat of a moot point given that the economy is receding quickly. The question is whether the Fed will pay attention to these signals and moderate policy sooner rather than later or if they will “reestablish their credibility” to create more economic slowing. Not surprisingly, I’m on the side of Wharton professor Jeremy Siegel. In his recent comments, he has pointed out that most economic data is coming in below expectations. He admonishes the Fed to not just look at data in the rear-view mirror but to pay attention to what’s happening in real time. [2] The ultimate goal of the Fed should be to try and return the economy to long-term trend growth around 2% without doing too much damage on the way there. Whether or not they are successful at that goal is yet to be seen.
Sources:
1. TC2000 Charting Software