Fed may encounter some policy mistakes leading the US economy into recession in coming years.Will USD/JPY test 105 again?
Federal Reserve Bank of St. Louis President James Bullard said he doesn’t support more interest-rate increases unless there are upside surprises, in part because the yield curve may become inverted.
We think the “upside surprises” he mentioned refers to inflation.
There is a risk that if the Fed continues to raise rates and long-term bond yield do not to follow. Inverted yield curve could be seen within 2018, which is a signal of recession.
US 2/10 govt. bonds yield spread is at 43 bps, vs 105 bps this time last year.
Implied forwards are already pricing in for curves to be heading towards zero in 2019, on expectations of additional 2-3 rounds of Fed interest-rate hikes and balance-sheet unwinding.
The Fed hiking with flat yield curves has preceded the last two recessions. It took two-four years between flat forward curves and a recession.
Perhaps the Fed slowing or pausing its hikes as forward curves price for flat yield curves could delay or prevent a recession, but such strategies have never been implied before.