One of the biggest stories in finance and economics in 2018 is the flattening yield curve. It has been flattening for a few years, but now it is coming close to an inversion as we have detailed previously. The latest difference between the 10-year treasury yield and the 2-year treasury yield is only 47 basis points. Stocks do fine when it is in its flattening period. If you are interested in finding out what performs best during an inverted yield curve, click here. Recessions usually occur when the curve starts to steepen after the inversion. The flattening in 2018 is occurring because economic growth has been stalling out while the Fed plans to hike rates 3 or 4 times even as the core PCE growth is only 1.6%, which is below the goal of 2% inflation.

The Fed is raising rates despite core PCE being below the target because it is afraid of a recession occurring while the Fed funds rate is low and because it thinks inflation is coming soon because of the tightening labor market. As you can see from the tweet below, the San Francisco Fed President thought the labor market was very near full employment in March 2015.

Fed President Wrong About Full Employment 3 Years Ago

Mistaken Labor Analysis

Three years later since the statement and the labor market still hasn’t gotten to full employment. That was a big mistake because he didn’t factor in the workers who left the labor force and are now re-entering it. If you look at the unemployment rate, which is at 4.1%, and the jobless claims which is at 215,000, it looks like the unemployment is low enough to spark price inflation. However, these measurements are missing the millions of workers who left the labor force in 2008 and are now re-entering. The jobless claims reports are a bit ridiculous in the sense that they show the labor market is impossibly tight even though it still has some more slack.

The latest jobless claims report is the lowest since 1973. In 1973, the labor force was 87 million and in 2018 it is 162 million. The claims to labor force ratio blow away the record low. The chart below explains why this is happening.

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