A key Federal Reserve official on Wednesday said that an inverted yield curve would not necessarily point to an imminent recession, despite its historical track record in doing so.
The comment, from Gov. Lael Brainard in a speech to the Detroit Economic Club, isn’t hugely different from comments Brainard made in May on the topic, or from other Fed officials including New York Fed President John Williams. What her remarks do suggest is the Fed won’t let the prospect of an inverted yield curve deter the central bank from continuing to lift short-term interest rates.
Brainard told the Detroit audience that this time is different.
“Like many of you, I am attentive to the historical observation that inversions of the yield curve between the 3-month
and 10-year Treasury rates have had a relatively reliable track record of preceding recessions in the United States,” she said. However, the current 10-year yield
is around 3%, compared with the average of 6.25% before the financial crisis.
Market expectations of interest rates in the longer run are themselves quite low, and also the term premium — the compensation investors require for taking on duration risk — is low.
“If the term premium remains very low, any given amount of monetary policy tightening will lead to an inversion sooner so that even a modest tightening that might not have led to an inversion historically could do so today,” she said.
So, why is the term premium so low? One reason, she says, is the changed correlation between stock
and bond returns, likely associated with changes in expected inflation outcomes. Another reason is the asset purchases of central banks in major economies.
Brainard, who as a Fed governor gets a vote at every meeting, says further gradual increases in the federal-funds rate will likely be warranted. “With fiscal stimulus in the pipeline and financial conditions supportive of growth, the shorter-run neutral interest rate is likely to move up somewhat further, and it may well surpass the longer-run equilibrium rate for some period,” she said.