The Fed demands to start off worrying far more about the flattening treasury yield curve.  Bloomberg is reporting that bond traders are finding prepared for a yield curve inversion as quickly as subsequent week.  1 fixed earnings manager quoted in the post had this to say:
If the Fed decides to move far more this year, I consider it is inevitable that the curve inverts and I consider it will be a error,” stated Colin Robertson, managing director of fixed earnings at Northern Trust Asset Management… He sees higher than a 50 % possibility of the two- to 10-year spread inverting if the Fed raises prices when far more this year, and if the central bank follows its projections and hikes twice far more, Robertson sees inversion as a lock.
For substantially of the previous year or so, investors and economists have anxiously watched the relentless shrinkage of the gap in between brief- and lengthy-term U.S. bond yields to the narrowest levels given that 2007. Following all, an inversion —  when lengthy-term yields fall beneath brief term ones — preceded every single of the final seven recessions. But when absolutely everyone has been so focused on the U.S, they seemed to have missed the international yield-curve inversion.
Inside the previous two months, the yield on an ICE Bank of America index of government bonds due in seven to 10 years has fallen beneath the yield on an index of bonds due in 1 to 3 years for the 1st time given that the 1st half of 2007. The strategists at JPMorgan Chase & Co. stated they have been seeing the exact same point in indexes they handle. Despite the fact that the U.S. economy is in strong shape, there have been indicators of weakness in the euro zone, China and emerging markets more than the previous month.
“I have had extended conversations with my colleagues about a flattening yield curve” and the dangers of it inverting, he stated at a moderated forum in Augusta, Georgia on Wednesday. “We are conscious of it. So it is my job to make certain that does not come about… Hopefully we will not get to that inversion.”
That is superior to know. Regrettably, other people on the FOMC are far more sanguine about the flattening yield curve. From the May well FOMC meeting minutes we find out the following:
[P]articipants also discussed the current flatter profile of the term structure of interest prices. Participants pointed to a quantity of elements contributing to the flattening of the yield curve, like the anticipated gradual rise of the federal funds price (and) the downward stress on term premiums… A handful of participants noted that such elements could make the slope of the yield curve a much less trustworthy signal of future financial activity.
Update: I got into a twitter conversation with regards to this post and my critique of Ben Bernanke’s speech in 2006. As a outcome, I constructed the following figure applying the New York Fed’s estimates of term premiums. It shows the 10 year minus 1 year treasury spread decomposed into (1) an anticipated price path spread and (two) a term premium spread. These two element add up to the all round spread.
The figure reveals that when Bernanke was ideal about a declining term premium in 2006 it was also the case that the anticipated path of brief-term prices was declining. It was signaling recession. What this implies for currently is that the FOMC must tread cautiously in interpreting the flattening of the yield curve. There may possibly be far more to the story than term premiums.