- Fed Study Says San Francisco Fed research blames low inflation, neutral rate
- There’s some risk that term premium could rise abruptly
(Bloomberg) — This isn’t Alan Greenspan’s yield curve.
“Perceived inflation risk could reverse its course quickly if inflation suddenly trended up,” Bauer says in the note. “Similarly, if investors’ expectations about the Fed’s balance sheet were to change suddenly, or if investor sentiment about the relative attractiveness of Treasuries deteriorated for other reasons, the term premium could rise quickly.”
Inflation has been low this year, with the Fed’s preferred index posting a 1.6 percent gain in September, well below the central bank’s 2 percent goal.
Liquidity moves markets!Click here to learn how you can follow the money.
Market-based indicators suggest that investors are starting to doubt whether inflation will accelerate. When investors expect prices to rise, they require extra return to hold longer-dated securities because of the risk that price gains will erode the investments’ value. But if they see a greater risk of tepid inflation progress, they’re willing to pay extra to hedge against low inflation — driving down longer-term bond yields and flattening the curve.
Likewise, Fed officials have gradually marked down their forecasts for how high they’ll ultimately lift their overnight policy benchmark. The shift reflects a growing sense among policy makers that the neutral rate — the one that neither stokes nor slows growth — has declined and will stay low. Expectations about future short-term rates are a key determinant of long-term yields, so as markets followed the Fed’s lead, it probably helped to flatten the curve, Bauer writes.
Finally, expectations for fiscal stimulus drove up bond yields when Donald Trump won the presidential election last year, but have since waned. The study shows Treasury yields falling on days with negative headlines about domestic politics and geopolitical risks.
Yeppers, core inflation is still 1.33% and the neutral real rate is 1.40% leading the San Francisco Fed to generate a Taylor Rule estimate of 5.96% for the Fed Funds Target Rate, while it is only 1.25% — A GAP OF 471 BASIS POINTS.
Yes, the Taylor Rule gap is higher now that during Greenspan’s tenure as Fed Chair, mainly because core inflation is lower under Bernanke/Yellen.
But notice that core inflation declined to under 1% in 1998 under Greenspan. But 10-year Treasury note volatility is near an all-time low (under 4).
Cheers to Alan Greenspan, the architect of monetary expansion!
Wall Street Examiner Disclosure:Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. I am a contractor for Money Map Press, publisher of Money Morning, Sure Money, and other information products. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. In some cases I receive promotional consideration on a contingent basis, when paid subscriptions result. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. No endorsement of third party content is either expressed or implied by posting the content. Do your own due diligence when considering the offerings of information providers.