The Yield Curve Curves Again

Last summer, the then-future rate hike was moving ahead in time, always 6 months in the future.  Until we revive the mortgage credit market and the single family homebuilder market, that may be the best we can hope for.  Where is capital supposed to go if we effectively obstruct trillions of dollars of potential investment?

As we moved through 2015, the Fed decided to impose a rate hike, and so, finally, the expected date of the rate hike became anchored in time, and we finally caught up to it in December.  Since then, the yield curve has flattened sharply.  In fact, we may be near the equivalent of an inverted yield curve now, with forward rates boosted by distortions of the zero lower bound.

In the most recent rate hike periods, rates have risen by about 50 to 70 basis points per quarter. During QE3, the slope implied future rising rates of only about 15 to 35 basis points per quarter.  I suspect this partly reflected expectations of slower rises and partly reflected expectations that we would not leave the zero lower bound.

Now that the Fed hiked rates, the slope has declined all the way to about 8 or 9 basis points per quarter.  There is also a lot of uncertainty about the date of future rate hikes.  This is so low that I think it reflects a very strong expectation that rate hikes will never come.  Long term rates in Japan were in the 2% range until recently during a long period of low short term rates.  This is basically a flat yield curve.

The fact that there isn't a unanimous call for the immediate reversal of the rate hike is pretty much the picture of our dysfunctional era.  We know what we want, "and deserve to get it good and hard."

In the meantime, the short end of the yield curve now curves up yet again.  And, we are back to a context where the next future rate hike is expected to be about 6 months in the future.  Probably the best we can hope for is that we are back in the context of the ever-moving rate hike, always 6 months in the future.  If we ever start building homes again, maybe it can rise naturally.  Until then, if the Fed decides to continue to pretend it controls short term rates in some sort of Phillips Curve fantasy, then they will push us over the edge again.  This time, though, it won't be preceded by a housing collapse or a tepid, but manageable NGDP growth path, because there is little housing market to ruin and NGDP growth is already tepid.  We basically are already back to 2007, where wage growth is strong, but is all being eaten up by rising rents.  I don't see any reason to think we can't walk right back into a 2008 situation, given public and FOMC viewpoints.