Since last Thursday, the yield on the long-term Treasury bond is down by about 10 basis points. Since its recent peak a little over three weeks ago, the yield is off by 16 basis points.
On Friday, though, rates bounced back and have continued moving higher early this week. The deal between the UK and the European Union over Brexit (remember that?) helped drive global yields higher, but, soon after, they moved back to Friday’s closing level of around 3.08%.
Despite the near-certain rate hike this week, investors don’t seem all that worried about the economy overheating or inflation rearing its ugly head.
It’s not just that long-term yields have dropped; the spread between short-term and long-term yields (otherwise known as the yield curve) is flattening as well.
I’ve often noted that a flattening yield curve could signal trouble ahead for the economy, and when long-term yields go lower than short-term yields, or invert, the economy will fall into a recession.
Take a look at the change in the yield curve over the last month alone:
It’s not close to inverting, but it’s definitely getting flatter. That’s worrisome. In fact, every recession since 1955 has been preceded by a negative spread between the 10-year Treasury note and the one-year Treasury bill.
President Trump’s steel and aluminum tariffs seem to be weighing on the markets, and so does recent economic data.
February’s Consumer Price Index (CPI) came in mostly as expected, but bearish bond traders (along with the Federal Reserve) were probably hoping for a surprise to the upside. Year-over-year core inflation (less food and energy) stayed at 1.8%.
Producer (wholesale) prices tend to be a leading indicator of where consumer prices will go. The February Producer Price Index (PPI) moved higher, as expected. Core PPI (less food and energy) moved up to 2.5% on the year and has been tracking above 2% for over a year now. Unfortunately for the Fed, it hasn’t translated into higher consumer inflation… yet.
February retail sales were even more disappointing, falling 0.1% on the month against expectations of a 0.4% rise. Even excluding autos and gas, sales only moved up 0.3% on the expectation of a 0.4% increase.
Last Friday’s February new home starts and permits were also below forecast. These numbers can be volatile from month to month, and January’s numbers were quite strong, so take these numbers with a grain of salt.
Before setting or changing its policy course, the Fed compares its outlook with emerging data and adjusts expectations, forecasts, and/or monetary policy.
Even though we’ve seen rather weak economic data along with subdued inflation and wage growth, the overall picture remains positive, and policy still dictates three rate hikes this year, including this week’s expected hike.
Remember, the Fed’s congressional mandate requires it to provide for maximum employment and stable prices.
Prices have been “stable,” but with 10 years of stimulation and abnormally low interest rates, the Fed hasn’t yet managed to hit its 2% consumer inflation target. And even though employment seems to be healthier today, with unemployment nearing 4%, wages haven’t really picked up yet.
Wages seem to be the missing ingredient to higher inflation, which, the Fed insists, is just around the cornrner.
So tune in Wednesday afternrnoon for the Fed’s rate decision and, more importantly, to find out whether its forecast and outlook have changed since the last meeting. Any surprises will surely move the markets!
Until then, you can prepare for and profit from surprises in the financial markets, and specifically in the Treasury bond market, with Treasury Profits Accelerator.
Till next time,