Philadelphia — Bill Poole says he's "been a bit puzzled" by talk beginning last fall that an inverted yield curve would likely herald a recession.
Poole, president of the Federal Reserve Bank of St. Louis, said in a speech to the Global Interdependence Center that when he agreed last fall to speak on that topic, market concern over an inverted yield curve was running high. "The Federal Open Market Committee (FOMC) had been providing guidance that it would probably continue to raise the target federal funds rate," he said. "Given the level of the 10-year Treasury yield in the 4¼ to 4½ percent range, market observers expected that the federal funds rate would soon be above the 10-year rate. Recession concerns were widely discussed, because in the past an inverted yield curve has often been associated with recession."
Poole said that, additionally, many found it odd that until last month the monthly average 10-year bond rate was actually lower than it had been in June 2004, even though the FOMC had raised the target fed funds rate from 1 percent to 4¾ percent. He quipped that "now that the 10-year rate has risen by another 50-75 basis points, apparently everyone feels a lot better!"
Commenting further on his concern about inversion/recession comments, Poole said that the 10-year/fed funds spread "never became negative last fall and still isn't." Yet, he said, inversions associated with recessions have been quite large. "Using monthly average data, the 1969 inversion reached 250 basis points; 1974's exceeded 500 basis points and the 1980 and 1981 inversions exceeded 600 basis points. Milder inversions seem to be associated with milder recessions. The 1989 inversion reached 125 basis points and the 2000 inversion reached 116 basis points. We never got close to any of these last fall."
Poole said that the term structure of interest rates provides a window into investors' interest rate expectations. "It's always worthwhile for policymakers to consider those expectations, but not wise to take them at face value without further analysis," he said. "Interest rate expectations reflect investor understanding of how rates will evolve, which is why an inverted yield curve has often preceded business cycle peaks. But the market's rate expectations also depend importantly on the market's read of what the FOMC will do."
Poole said that "as of today, the market's concerns last fall that the yield curve would invert and signal a recession seem to have evaporated. There is no obvious misalignment of market interest rate expectations and my own expectations. What I believe will happen is that FOMC policy decisions and market expectations will evolve as newly arriving data either change or affirm the current outlook for the economy."
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