The yield curve’s still weird

18 Jan 2020

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ST. LOUIS: It was more than a year ago when St. Louis Federal Reserve bank President James Bullard started raising the alarm about a US bond market where interest rates seemed to show investors losing faith in the economy, a risky environment for the Fed to carry out planned rate increases.

As 2020 gets under way, the closely watched spreads between long- and short-term Treasury securities still don’t look completely healthy.

But with months of market turbulence and three rate cuts now in the rear view mirror, Bullard says he is ready to stand down, leave policy on hold for up to a year, and see what transpires.

“We eased substantially in 2019. That will come on board in 2020,” just as the United States and China also signal an easing of trade tensions with the Wednesday signing of a preliminary agreement, Bullard said in a Reuters interview. “We will see how much impact we have in the first half of 2020 and probably all the way through 2020, and then we will see where we are.”

That’s a shift for Bullard from what had been aggressive stumping, beginning as far back as late 2017, for the Fed to beware of raising interest rates too much, in part because of the behavior of the bond market.

But it is also further indication of a broader consensus that may well keep the Fed on the sidelines, with interest rates unchanged, throughout a potentially turbulent US presidential election season. The last year was a rocky one for the Fed, with markets upended by a global trade war, the central bank the target of verbal attacks by President Donald Trump, and policymakers divided on what the economy needed. Over the year there were dissents against the Fed’s quarter-point rate cuts coming from those who believed policy should be even easier and those who thought the opposite.

Bullard dissented twice in favor of deeper and faster cuts.

As the year ended, Fed officials across the spectrum agreed they could pause any further rate moves until something in the economy changes.

For those like Bullard who might have wanted even lower rates, it’s an acknowledgement the economy is still absorbing the massive shift toward looser monetary policy that the Fed engineered last year when it lowered the overnight policy rate to its current range of between 1.5 per cent and 1.75pc. For those who might have once been concerned about inflation or financial risks it’s an acknowledgement that as of now there’s little evidence of either.

Published in Dawn, January 18th, 2020