Economy | Fixed Income
Yield Curve Inversion - How May the Fed Respond?
Posted onA key slice of the Treasuries yield curve became the most inverted since 2007. Additionally, long-term yields on government bonds around the world are hitting some of their lowest levels in recent years.
This is largely due to ongoing concerns about the impact of the US-China trade war on global growth, tensions between Italy and the European Union, and the lack of agreement over how Britain will exit the European Union.
The gap between 3-month and 10-year rates dipped on Wednesday to -12.3 basis points, breaking past a March level, when it first reached levels last seen in the global financial crisis. However, the bigger curve inversion (2-year yield vs 10-year) is yet to take place and suggests markets are nervous but reserve judgement on the prospects of a US recession.
Nevertheless, should trade tensions escalate, then a further move into the safety of longer dated Treasuries by investors cannot rule out a bigger 2-year vs 10-year yield spread inversion.
How could the US Federal Reserve respond?
In Citi’s view, financial markets are pricing Fed rate cuts more aggressively amid strong trade headwinds. This looks excessive and Citi analysts expect the Federal Reserve to remain on hold in 2019 and 2020 given that
- Minutes from the May FOMC meeting suggest that the current patient stance to determining monetary policy is likely to persist for “some time.”
- Citi analysts expect US growth to moderate from 2.9% in 2018 to 2.7% in 2019 with fading fiscal stimulus and slower investment, but still robust consumption is likely to be supportive.
