Yield Curve Partial Inversion Reaction Leads to Some Steepening

Markets sold off heavily last week as the yield curve partially inverted, the first inversion since before the Great Recession. The sell off immediately spurred a flight to quality, the 10 year T yield dropped a low 2.82% on Monday, the 2 year dropped to 2.69%. The “inversion point” of the 3 and 5 year Treasuries is now less than 1 basis point (3 year at 2.775%; 5 year at 2.699%). Maybe recession fears are “so last week” as the market is now cheering progress in US – China trade talks. But the curve is nowhere near a “healthy” steep curve. Recent statements by ex Fed Chairs Bernanke and Yellen indicate a feeling that this indicator may not be relevant. Bernanke pointed out that “regulatory changes and quantitative easing in other jurisdictions” has distorted the “normal” market signals (by normal he means the “old normal”). The Fed seems set on raising rates next week, despite pressure from the executive branch to leave rates unchanged. The pressure may actually end up convincing the Fed that they must raise rates in order to retain credibility (for a lesson in central bank meddling, see recent economic events in Turkey). The question then becomes how many increases in 2019? Futures markets in Fed Funds and the LIBOR curve have lowered their 2019 rate forecasts considerably over that past few weeks as economic growth expectations continue to cool in China and Europe, and the effects of tax cuts and government spending will be wearing off in the US. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners