As markets turn, Federal Reserve says it is not fazed by changes
WASHINGTON: US Federal Reserve officials convinced the massive US bond market has fundamentally changed in the last decade are about to test their commitment to that idea against investors who have begun betting against the US central bank’s ability to continue raising interest rates.
In what could set the stage for a volatile 2019 if the Fed acts more aggressively than investors expect, top policymakers are maintaining their view that nosediving bond spreads don’t give the same sour signal about the economy that they used to.
Investors typically demand higher yields to commit money for longer periods of time.
When short- term rates rise above long-term rates and ‘invert’ the yield curve, it has been a reliable predictor of recession, though sometimes several months later, as confidence in the economic future erodes.
Instead of just reflecting investors losing faith, Fed officials have argued that the recently narrowing gap between short- and long-term Treasury bonds could reflect longterm shifts in global capital flows, or the fact that all interest rates are lower and more compressed together than they used to be.
The central bank’s own large balance sheet may even be a culprit, by helping hold down long-term rates.
Other forces may be at work that would not necessarily change the Fed’s underlying plans, such as a recent drop in oil prices that could hold down the interest demanded by investors by lowering expected inflation.
The closely watched spread between two-year and 10-year bonds dipped below 0.1 percentage point on Tuesday, the lowest since before the last recession and continuing a slide that began in October.
US stocks slumped nearly three per cent on Tuesday on some of the same growth concerns influencing bond investors as well as on doubts China and the United States would resolve their trade spat.
Far from the US facing trouble, however, New York Fed president John Williams said on Tuesday the economy is strong and the base case outlook is for rate increases to continue through 2019.
“I do continue to expect that further gradual increases in interest rates will best foster a sustained economic expansion,” Williams said at the New York Fed.
“Sometimes there will be market reactions or interpretations of things that move around.
But I think I’m focused on our goals and getting the policy right,” Williams said.
That has been a common view at the Fed, including among top officials like Chairman Jerome Powell. — Reuters