Ignore the Fed’s Yield Sign at Your Peril
If the Federal Reserve’s rate projections come true, the yield curve is bound to get flatter
By Justin Lahart
Sept. 24, 2017 11:00 a.m. ET
The Federal Reserve is telling investors it will flatten the yield curve. They should listen.
Last week, policy makers stuck to a projection that they will raise their target range on rates by another quarter point this year. But they also lowered their median projection of where they think rates will eventually be to 2.75% over the longer run versus their June forecast of 3%. That matters to the bond market because Treasury yields reflect investors’ expectation of what overnight rates will average across the maturity of Treasurys, plus the “term premium,” the extra yield investors demand for the risk of lending over a longer term. Historically, term premiums have been positive but lately have been negative.
Based on the Fed’s projected rate path and current term premiums, the 10-year Treasury yield seems about right. Nor should yields rise much as the Fed raises rates, because those rate increases would only raise the average level of short-term rates over the 10-year’s maturity slightly. Average rates over shorter maturities, such as for the 2-year Treasury, would rise more. The Fed’s projections suggest the yield curve will flatten.
Fears that a flat curve is an economic distress signal may not pan out, but it does lead equity investors to reduce risk, points out Cornerstone Macro’s Roberto Perli. Shares of banks and credit-dependent firm often underperform.
The Fed’s expected rate path might not come true. Low inflation could lead it to raise more slowly. High inflation could do the opposite. And even if the Fed turns out to have been right, an increase in term premiums could alter the curve’s shape. But for now, investors should be careful not to get flattened.
wsj.com
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The United States1. US homebuilder optimism index (from the NAHB) was softer than expected. Part of the reason was the concern over construction supplies due to Hurricanes Harvey and Irma ( see story).
The Commercial Construction Index also showed some moderation.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
Although it remains a significant issue, contractors are a bit less concerned about finding skilled labor. Hiring needs have eased somewhat.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
One issue that is becoming increasingly acute, however, is construction materials shortages.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
2. Commercial property prices have firmed up again amid persistently low longer-term interest rates.
Source: Green Street Advisors
3. Hurricane Harvey is expected to have a meaningful impact on residential building permits in the US.
Source: Wells Fargo, @joshdigga
4. As discussed yesterday, here is what Harvey did to the US industrial production. The chart below also shows Katrina and Ike (although it’s tough to separate Ike from the recession).
The United States1. US homebuilder optimism index (from the NAHB) was softer than expected. Part of the reason was the concern over construction supplies due to Hurricanes Harvey and Irma ( see story).
The Commercial Construction Index also showed some moderation.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
Although it remains a significant issue, contractors are a bit less concerned about finding skilled labor. Hiring needs have eased somewhat.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
One issue that is becoming increasingly acute, however, is construction materials shortages.
Source: U.S. Chamber of Commerce, USG Corporation; Read full article
2. Commercial property prices have firmed up again amid persistently low longer-term interest rates.
Source: Green Street Advisors
3. Hurricane Harvey is expected to have a meaningful impact on residential building permits in the US.
Source: Wells Fargo, @joshdigga
4. As discussed yesterday, here is what Harvey did to the US industrial production. The chart below also shows Katrina and Ike (although it’s tough to separate Ike from the recession).
Source: Capital Economics
In a way, Harvey can be thought of as a negative supply shock, raising inflation and reducing consumption.
Source: @RenMacLLC, @josephncohen
5. Next, we have some updates on inflation.
• This chart shows price trends for the three components of consumer inflation over the past couple of decades.
Source: @HayekAndKeynes
• The 3-month core CPI series changes show the recent bounce in inflation.
Source: Bloomberg
• Longer term, the weakness in labor cost growth suggests benign inflation ahead.
Source: Capital Economics
• However, the recent dollar weakness is likely to push up import prices.
– Here is the yearly change in the trade-weighted US dollar index.
– And these charts show the correlation between the dollar and US import prices.
Source: Credit Suisse
Source: Capital Economics
6. The increasing divergence between the average and the median household incomes tells us that the wealthier families are outpacing the overall population. Also, the average household size continues to shrink.
Source: Capital Economics
In a way, Harvey can be thought of as a negative supply shock, raising inflation and reducing consumption.
Source: @RenMacLLC, @josephncohen
5. Next, we have some updates on inflation.
• This chart shows price trends for the three components of consumer inflation over the past couple of decades.
Source: @HayekAndKeynes
• The 3-month core CPI series changes show the recent bounce in inflation.
Source: Bloomberg
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