Real Wealth Concepts

What the yield curve is saying now vs 6mths ago

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Inflation: Cooling but not cool

While the general trend is down, the month-over-month change in prices was higher than expectations (0.4% vs 0.3% expected). Extrapolating these month-to-month changes forward, annual inflation rates would still be more than double the Fed’s target.

It’s still too early to declare victory, despite Paul Krugman’s bizarre tweet today.

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Inflation: It ain’t over till it’s over

People are pointing to these charts suggesting we may be in for multiple inflation waves. I’m skeptical of these charts – inflation doesn’t have to follow a certain historical path. Moreover, the undercurrents driving inflation during the 1930s/40s and 1970s aren’t identical to today. I’d also argue that central bankers today benefit from the lessons learned during those times.

Still, it’s human nature to make mistakes and to overstate control, so it’s important to recognize that inflation might not return to normal as quickly as people hope.

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This probably means higher for longer

Assuming the Fed has learned from the past and doesn’t get complacent, it’s unlikely policy rates return to the 2010s average. This doesn’t necessarily mean inflation remains especially elevated. More that yields will be given the opportunity to normalize.

Going back to the 1950s, it’s clear that today’s 10yr UST yield of about 4.7% is in-line with historical averages. The average yield going forward is more likely to depend on where nominal economic growth – population growth, productivity growth and inflation – averages over the next decade.

Of course, we’re talking about averages here. Buried within the data are peaks and valleys that form with the business cycle. A higher-than-average yield or inflation rate over the next several years doesn’t mean we can’t experience a deflationary trough sometime over the next 18 months.


Did someone say “deflationary trough”?


The slow moderation of inflation combined with relatively strong employment stats have the markings of a soft landing, yet other indications suggest the winds could rapidly chill. Contracting credit, shrinking money supply and a higher cost of capital are all pushing the economy towards a cliff. This is showing up in yield curve dynamics.

Remember the massively inverted yield curve? Well, it’s not so massive anymore. The 2s-10s spread is narrowing. This is bad news – it’s called a ‘bear steepener’. As you can see in the chart below, recessions are first preceded by an inverted yield curve FOLLOWED BY a steepening curve.

Seems like the bond market is yet again trying to tell us something.

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