The Dangerous Treasury Yield Curve

Popular Economics Weekly

New Federal Reserve Chairman Jerome Powell has maintained that the Fed is on track to raise their short term interest rates at least 3 times this year. Why? It sees higher inflation down the road because of the huge federal budget deficit, and growing federal debt that now totals more than $20 trillion, combined with declining tax revenues due to the recent tax cuts.

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Graph: Marketwatch

But that’s not the real danger to continued growth, according to a new report by the San Francisco Fed. It is the danger than short-term interest rates may rise above long term bond rates, which would be what is called an inverted yield curve. And an inverted yield curve has correctly signaled all nine recessions, with only one false positive in the 1960s, says the SF Fed.

Why? When short-term rates exceed long-term rates, the banks’ cost of money exceeds what they can earn, which makes it less profitable for them to lend. This can choke off available credit. The above graph shows the last 3 recessions when the yield curve was negative—in 1991, 2001, and 2007.

I maintain the inverted curve is one of the reasons for recessions, but not the only reason. It has to do with why long term Treasury bond rates are still so low in the ninth year of this economic recovery, and the 10-year bond yield is still below 3 percent.

The underlying reason rates are low is because there isn’t enough aggregate demand for the $trillions in excess cash being held by corporations, the Fed, and banks. That is to say, it’s not being used for investment purposes, or returned to the employees of those businesses. Instead, it’s being hoarded or used to buy back their shares, which inflates stock prices but doesn’t increase the demand for their goods and services.

Boosting aggregate salaries of their employees would do that, as the incomes of wage and salary earners aren’t even keeping up with their spending, which is why the personal savings rate is just 3.2 percent, when it should be at least double at this stage of an economic recovery.

Macroeconomists look at aggregate demand to predict economic growth, which is the sum of activity in the private and public sectors. And they see weak demand, because average household incomes haven’t risen faster than inflation over the past 30 years.

In other words, average real household incomes have literally not grown at all when inflation is factored in as I said last week. This has been happening since the 1980s when trickle-down economics came into vogue, which said that the owners of capital and industry should receive the lion’s share of national income (via lower taxes and regulations), and that would create more jobs and growth for everyone.

So beware of another inverted yield curve, if the Fed continues to raise their rates as predicted. And stock traders know that. Hence the extreme price volatility of late. They see the same shrinking credit and declining growth picture, if long term bond rates don’t begin to rise soon.

But that won’t happen unless corporations and our government actually begin to spend their monies on productive uses, not tax cuts and share buybacks.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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