‘More normal’ yield curve bullish sign for 2020

The way US bond markets responded to recent Federal Reserve interest rate cuts could be “bullish” for the economy, St Louis Federal Reserve President James Bullard said, adding he was ready to keep rates on hold and see how it plays out. “The Fed has made a major move in 2019 and it makes sense to wait and see how the economy responds during the fourth quarter and into 2020,” with growth possibly exceeding 2 per cent next year as the full impact of the Fed’s rate cuts is felt, said Bullard.

As businesses adjust to global trade policy disruptions and the fallout of the Us-china trade dispute, Bullard said, growth next year could also get an unexpected bump.

“If you think that trade policy uncertainty has caused a year or more of adjustment — if we get through that whole process — I would call that success,” even if businesses have rearranged supply chains in less efficient ways and tariffs remain in place, he said.

Bullard’s comments line him up with the consensus among Fed officials that rates can remain on hold for now. He had been among the earliest policymakers to flag concerns about a possible “inversion” of the yield curve, urging rate cuts if only to acknowledge that traditionally bearish signal.

The yield curve is inverted when short-term securities pay a higher rate of interest than longer-term ones, suggesting that financial markets expect a recession. But after briefly inverting this year, the yield curve has returned to the normal upward slope.

“The (Federal Open Market Committee) has taken actions that have changed the outlook for shorter-term US interest rates considerably over the last 12 months, ultimately providing more accommodation to the economy,” Bullard said.

“Key measures of the US Treasury yield curve have now returned to a more normal, positive slope, possibly a bullish factor for 2020,” which now shows markets and the Fed in closer alignment about appropriate monetary policy, Bullard said.

The Fed has reduced interest rates three times this year, cutting its target policy rate by 0.75 percentage points to a range of 1.5 per cent to 1.75 per cent. Bullard was among the main advocates for lower rates.

On Thursday, he said the actual level of support provided for the economy may be much larger than that, since the Fed at the start of the year also took planned rate hikes off the table.

All told, the Fed’s policy shift was perhaps the equivalent of a 1.32 per cent drop in rate expectations this year, “a very large change over this time frame,” Bullard said.

“The bottom line is that US monetary policy is considerably more accommodative today than it was as of late last year.”