It’s hard to believe, but the yield curve is getting steeper in the wrong direction. Well, it’s the wrong direction for anyone not prepared for a brutal recession ahead.
This week, the financial media and even some Fed officials are saying that another 25 basis point rate hike by the Fed might be necessary. This is in order to fight that stubborn inflation that the Fed created in the first place.
With this, the short-term yields went higher this week. The one-month yield went from 5.69% on Monday to 5.95% on Thursday. At the beginning of the month, it was at 4.49%. The other short-term yields did not go up this dramatically.
The longer-term yields have gone up a little bit this month, but not to that degree either. So the inverted yield curve gets more inverted, at least using the 1-month yield.
The spread on the 3-month yield and the 10-year yield is 155 basis points. It is even worse comparing the 1-month to the 10-year, which is 212 basis points.
The crazy thing is that the yield curve has been inverted in most spots for the entire year (since January 1, 2023). How long will this go on for?
Timing a Recession
While the market forecasts another federal funds rate hike, it also projects that the rate will be lower than where it is now by the end of the year.
If the Fed is in this desperate fight against inflation, why would it start lowering rates again in 2023? The only answer is that we will be in a brutal recession, which will include more failing banks.
The timing on all of this is hard. It is typical for an inverted yield curve to become uninverted (if such a term exists) before the worst of the recession hits. It’s hard to say what will happen this time.
It’s also not clear if there is causation or correlation. If a recession becomes evident, then investors are likely to go into long-term bonds, which would drive long-term yields lower. But the Fed would also likely react with a lower target rate.
The Price Inflation Factor
The additional complicating factor in all of this is price inflation. When the financial crisis hit in 2008, price inflation wasn’t a big factor like it is now.
If price inflation is coming down with the onset of a recession, then expect the Fed to drop rates again and possibly go back to QE (i.e., creating money out of thin air).
But what if price inflation is still stubbornly high? If the CPI numbers are still coming in at 5%, will the Fed risk losing control of the dollar in order to “save” the economy.
As I have said many times, I don’t think the Fed is going to intervene to save the stock market. I don’t think the Fed will intervene to lower unemployment. I think the Fed will only intervene if major financial institutions need to be bailed out or if the bond market is in major turmoil.
The Fed does not want to further jeopardize the dollar’s status as the world reserve currency. It certainly does not want to destroy the dollar. The Fed is reckless, but not as reckless as Joe Biden and company. If the Fed loses control of the dollar, the Fed officials risk their own power.
The Fed is also not going to purposely try to save Biden’s presidency. Fed officials care more about themselves than who is president.
The recession should be in full swing by the 2024 election. This is a major factor that isn’t getting much discussion in all of the political talk out there.