For the first time in 16 years, yields on 5-year and 30-year treasuries are inverting.Can Powell be trusted to protect the economy?

2022-07-11 0 By

The yield on the US five-year Treasury note climbed 9 basis points to 2.63 per cent on March 28, higher than that on the 30-year bond, the first inverted yield curve since 2006, according to Zhitong Finance APP.Shorter-dated bonds have been selling faster than longer-dated bonds this year amid growing expectations that the Fed will raise interest rates to combat inflation.The yield curve is rapidly flattening as investors bet that the Fed will tighten policy quickly, risking slower growth or even a recession.Prashant Newnaha, strategist at TD Securities, said: “Fed officials have yet to pull back from aggressive market pricing, which now sees rising yields and a flattening curve as the trend.”This month, the Fed raised its benchmark interest rate by a quarter of a percentage point, the first increase since 2018.The Fed also pledged to continue raising interest rates to curb inflation, with Fed officials including Chairman Jerome Powell and St. Louis Fed President James Bullard saying they need to raise rates quickly and would raise them by 50 basis points if necessary.Traders are now betting that the Fed will raise rates by 200 basis points before the end of the year.Judging by the market’s performance, traders are worried that the Fed’s policy mistakes could tip the ECONOMY into recession.In response, Powell said right after the decision in March, “The probability of a recession next year is not very high.”He said FOMC participants still expect the ECONOMY to grow at a steady pace, recession risks are not particularly prominent, and the extremely tight labor market in the context of the economy remaining strong allows the economy to cope with multiple Fed rate hikes.However, he also acknowledged that the Russia-Ukraine situation poses a downside risk to US economic activity and the financial and economic impact is highly uncertain, with volatility in financial markets likely to tighten credit conditions and affect the real economy.Powell also dismissed fears that an inverted yield curve suggests a recession, arguing that Wall Street traders should look to the short-term yield curve, which he said is still steep.Powell believes the Fed has ample room to aggressively raise interest rates without stifling economic growth while fighting inflation.Powell’s view is shared by some Wall Street banks.Goldman expects the two – and 10-year yield curves to invert next quarter and last three years, but doesn’t see any dire economic consequences.Morgan Stanley also sees a curve inversion as a “natural consequence” of The Fed’s monetary policy, and while a yield curve inversion is imminent, it does not herald a recession.