Brainard
April 5, 2022
–Light volume Monday featured a slightly steeper curve with the ten year yield up 3.5 bps to 2.408% and twos down half a bp to 2.424% (still inverted). EDM3, the ED contract with the highest yield, made an overnight low of 9858.5, but closed unchanged at 9868.5, suggesting that selling pressure is abating. FFF3 settled 9753.5, indicating 200 to 225 bps of additional tightening this year.
–This week features a lot of Fed speakers (and FOMC minutes tomorrow) but perhaps Brainard’s comments today will be the highlight. I was looking for a previous speech of hers where she suggested the neutral rate was rising as the Fed was hiking, and found it in a May 31, 2018 piece titled ‘Sustaining Full Employment and Inflation around Target.’ I was struck at the time by the idea of a moving target on the neutral rate, seemingly bolstering the case for the Fed’s tightening regime at that time. She also noted the low term premium in the long end, a condition that is currently in place but may (as she predicted in 2018) expand. In any case, here’s an interesting excerpt on the yield curve:
“Since 1960, there has only been one case where the 3-month Treasury yield has moved above the 10-year Treasury yield and a recession has not followed–in 1966.9
This correlation between yield curve inversions and recessions might arise for a variety of reasons. First, let us take a case where short-term rates rise relative to long-term rates. When the FOMC is undertaking a deliberate tightening in policy, short-term interest rates typically rise, as do expectations of short-term interest rates in the medium term, while interest rates in the distant future may be less affected. For example, if short-term interest rates were raised to stabilize temporary swings in the economy, the logic of the expectations hypothesis would suggest that long rates would not rise as much. And if tighter monetary policy were to weaken the economy with a lag, this would lead to long rates not rising by as much or at all.
–Brainard doesn’t allow much room for debate as to the signal of an inverted curve. However, there has been a tendency of Fed officials to fit the economic narrative to the policy prescription. Should be an interesting speech, which I think might contain a slight pushback to current market pricing of aggressive near-term hikes. Title of today’s speech:
Variation in the Inflation Experience of U.S. Households
https://www.federalreserve.gov/newsevents/speech/brainard20180531a.htm
