Weekly Update and Blog Post
by Zach Marsh on Apr 24, 2018
Our Weekly Recap
S&P 500 +0.48%
10 Year US Treasury -0.97%
Our Weekly ReadingWhat began as a fairly promising week in the stock market, sort of withered on the vine the last two days. After posting a nice 2% return last week, the S&P 500 rallied another 2% between Monday and , only to give most of it back by the end of the week. Bonds also slogged through the week, posting a loss of nearly 1%.
Continuing to gain attention this week has been the steady collapse in the yield curve. The yield curve is what defines the slope of interest rates across various maturities. The Federal Reserve began tightening, or raising interest rates, back in December of 2015, and has continued to do so on a fairly consistent basis ever since. The interest rate curve flattens when the shorter term maturity rates increase at a faster rate than longer dated maturities. What is troubling about this is that a flat, or inverted (short term rates higher than long term rates) curve has been prelude to nearly every recession since 1959. Currently, only 45 basis points (0.45%) separates the rate on the 10 year bond from the rate on the 2 year bond. Below is a chart that shows the historical spread between the two maturities going back to 1980. This flattening has drawn the attention this week of James Bullard, St. Louis Fed President, who said, "The inverted curve is a powerful predictor of economic downturns."
Now it may make for interesting conversation about the predictive nature of this phenomenon, but the larger question for the Fed should be is this correlation or causation. Meaning if this is truly a concern, then seeing that the Fed rate hikes have not exactly spurred interest rates across all maturities to rise in kind, then maybe the Fed should consider pausing for a short period. The old saying that, "Bull markets don't die of old age, but are murdered by the Fed," might have some validity. If some of their members feel that a flattening curve precipitates a recession, then forcing short term rates higher, when the natural rates (long-dated ones) don't necessarily want to go higher should provide a clue that they may want to slow down. For now it looks like the Fed is eager to move rates higher and has hinted at another 3 rate hikes this year.
My gut says that the stock market eventually gives in to the Fed and that the rate hikes will cause more prolonged declines in the near future. If the economists believe that the long-term growth potential for the US economy is 1.8% GDP growth, then short-term rates higher than that seem unwarranted and detrimental to sustained growth.
Thanks for reading,
Zach and Dave