After taking a break last week, “Just the Facts” returns with fascinating interest rate news and analysis.
Over the last few weeks, there have been many updates to the monthly economic data – including housing starts and updates to the US quarterly GDP growth. All of those data points reconfirmed prior reads: that the short term economic growth implications are robust, that inflation is going up, and that the Federal Reserve’s Open Market Committee is justified in hiking the benchmark Federal Funds Rate a total of four times this year. However, data trickling in and confirming expectations is the boring part.
More fascinating is that the bond market seems to be expecting something different from the Federal Reserve. Normally, the Federal Funds Rate is not just a benchmark for short-term interest rates over periods of less than 5 years, but it also serves to influence longer term rates for periods over 5 years extending to 30+ years. In recent months, even as the Feds have bumped up the Federal Funds Rate – the bond market has seen markedly higher rates only on the short term interest rates. This implies that the bond market doesn’t believe growth & inflation will continue long term. If the Federal Open Market Committee comprises a few wise people, then the bond market contains all the entities and people that constitute the demand and supply for money today vs. in the future. And in an open economy like ours, markets have typically been right.
The graph below plots the difference between the implied interest rate on US treasury borrowing for 10 years vs. 2 years. The difference between short term rates and long term rates is less the lower this number goes. If this number trends negative, it’s a phenomenon called yield curve inversion. Every one of the past 5 recessions has seen yield curve inversion in the 12 to 21 months preceding its onset.
As mentioned in a previous “Just the Facts”, we have nothing to fear about a recession. It is normal; it’s a sign that the economy is active and is driven in the collective, as opposed to being maneuvered by some invisible hand.
What matters is the impact of impending yield curve inversion on interest rates, especially 30 year fixed rate mortgages. When the next recession happens, the Federal reserve will use policy measures to guide the economy to growth again. In a stable population country like the US, those policy measures invariably have an effect of lowering interest rates. We have no reason to believe that that the Federal Reserve will manage the upcoming economic cycle any differently.
Zooming back to a week-to-week view, the bond market activity resulted in yields dropping, and as a consequence, we lowered our interest rates by 1/8th of a point.