Short End Of The Curve Could Cause An Inversion

Inflation Breakdown

Since inflation was mentioned numerous times during Powell’s testimony and then in the interview with former Fed chairs Ben Bernanke and Janet Yellen, let’s look at a breakdown of the metric. As you can see from the chart below, the purple line shows the cellular data series Yellen referred to often last year. Yellen blamed this measurement for the decline in inflation. It doesn’t appear to be increasing since then even though overall inflation is picking up. Cellular prices weren’t the only cause of the decline. As you can see, housing, prescription drugs, and other pro-cyclical prices decelerated last year. The pro-cyclical and prescription drug inflation accelerated at the end of the year. The definition of pro-cyclical is something which acts in tune with the economy or magnifies its effects. It’s the opposite of counter-cyclical.

The pro-cyclical basket includes housing, recreation services, food services and accommodations, non-profit expenditures, and what the BEA defines as other non-durable goods. The chart makes it look like the market is overreacting to the slight increase in prices. The metrics in this chart will go up along with the Fed prices index this year, but they’re starting from a low level so the economy is far from overheating.

Focus On The Short End

I have been focusing greatly on the long end of the treasury yield curve. However, if you look at the chart below, it appears the real action is on the short end. As you can see, the long end has been relatively stable. As you get closer, the curve is more volatile. The rising rates on the short end are mostly responsible for the flattening of the curve. Therefore, regardless of how the balance sheet unwind affects the long end of the curve, the focus should be on how the Fed funds rate hikes push up the short end. If the Fed raises rates 4 times this year, I expect it will probably invert the curve. It all depends on how much economic growth pushes up the 10 year and 30 year yield. It also obviously matters how many times the Fed raises rates. I’m still expecting 3 for the year.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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