David Beckworth: The Fed Is Loading Torpedo Tubes, USS Economy in Sight

When the yield curve inverts, the US economy capsizes, sure as—well, sure as running some torpedoes into the hull of the USS Economy.

David Beckworth’s latest and worthy post regards the rather cavalier attitude at the US Federal Reserve as the central bank, seemingly on automatic pilot, targets rate hikes through next year.

The above chart is not comforting.

Yet, notes Beckworth, “the FOMC’s own summary of economic projections implies a yield curve inversion over the next year or so.”

Oh, is that all?

Already, various Fed FOMC members have mumbled something along the lines that “this time is different. “Rates and term premiums are lower than in earlier cycles.”

In a ray of hope, not all Fedsters are sanguine. Atlanta Fed President Raphael  Bostic said, “I pledge to you I will not vote for anything that will knowingly invert the curve,” in an August presentation.

But the bulk of members seem onboard with relentless rate hikes.

Some Breathing Room?

The yield on 10-year bonds did rise to more than 3% last week, indeed to 3.07%. Some maybe some breathing room can evolve.

In other news, the website Nextgov recently pointed out the US government will spend record heaps of money through September 30, as it ferociously cuts checks to unload everything the Congress appropriated for the fiscal year ended Sept. 30.

To appreciate the scale of the undertaking, Nextgov points out the Pentagon cut $331 billion in contracts in fiscal 2017, but has to cut $411 billion in contracts in fiscal 2018—but this year’s budget and appropriations passed six months late. The Pentagon has a mountain of checks to issue this month, or give the unspent money back the US Treasury, a form of heresy.

As a result, a big slug of money is going to enter the economy in September, and probably help make Q3 and Q4 GDP figures look good.

One can hope the demand pressure will drive up inflation, and thus drive up long-term interest rates and postpone the recession-inducing inverted yield curve—the very condition Fed itself is all but targeting.

Conclusion

But how long can the GOP spend-a-thon go on? And will the soaring federal outlays actually push-up inflation and thus long-term interest rates?

Of course, there is much in this picture that looks like it could end badly, with a recession and interest rates headed back to zero, while the Fed appetite for quantitative easing is curtailed, given that it has so committed itself to “normalization” and a smaller balance sheet.

The US government can run even bigger deficits, but that prospect looks disagreeable as well.

And no one at the Fed even wants to even bring money-financed fiscal programs into the conversation.

Investors will have to keep an eye on the yield curve.  A dicey stretch is ahead.

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