US yield curve steepens again

Alex Moffatt

Bond yields around the globe rose again yesterday as dealers moved to accommodate the changing tone emanating from the major central banks. The USs 2 / 10 spread has moved from 80 basis points to 98 in just a week.

Let's look at some of the unwritten consequences of easy monetary policy. One of the many unmentionables of the past 20 years is the simple truism that in any downturn the weakest in society get hit hardest. In trying to soften the blow for that group, the financial environment also improves for the not so weak and it is those people who get to benefit most from the accommodative interest rate policy. Thus, while the initial objective is to stop the many from going under, the outcome is asset price inflation which in turn leads to the few getting richer and richer and the wealth gap widening. Thus, quite inevitably, any tightening of monetary policy will take its toll and once again those who are most exposed will be the ones who take it on the nose hardest. Whether the Fed doves believe that a slower normalisation of monetary policy can prevent the car crash or simply slow it down isn't quite clear but the hawks would appear to have acknowledged that if a car crash were to happen, best get it over while the mood in the economy is still positive and the sooner the bitter pill is swallowed, the better. One thing both sides apparently agree on is that unconventional measures cannot continue forever. On the surface the discord is over timing but below the surface there are clearly fears about what the suite of unintended consequences might be made up of. Fixed rate mortgages might protect America's middle classes from most of the impact of higher interest rates but the rising defaults in the auto and student loan spaces, already at worrying levels, will barely improve. My view remains that it is perfectly possible the monetary authorities can drive inflation higher rather than lower with higher interest rates and that after nearly a decade of experimental monetary policy there is no reason not to extend the experimental period and to try to pull rather than to push inflation through the interest rate structure. Kind regards

Alex


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