ECN135 The Yield Curve discussion Read the above article about the “yield curve” and discuss the following. The article mentions that the yield curve often

ECN135 The Yield Curve discussion Read the above article about the “yield curve” and discuss the following. The article mentions that the yield curve often flattens when the Fed raises short-term interest rates. Does that match what we know about liquidity premium theory? Assuming that the yield curve does flatten when the Fed raises short-term interest rates, should the Fed never raise short-term interest rates? What are the pros and cons of that policy?Your response must be 400 to 600 words U.S. News — THE OUTLOOK: Fed Debates Signal
From Yield Curve
Timiraos, Nick . Wall Street Journal , Eastern edition; New York, N.Y. [New York, N.Y]09 July 2018: A.2.
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Atlanta Fed President Raphael Bostic and some of his colleagues are laying the groundwork to slow down the
Federal Reserve’s interest-rate increases if they foresee a bond-market development that has traditionally been a
harbinger of recession.
At issue is the narrowing spread between short- and longer-term Treasury yields, a difference known as the yield
The gap typically shrinks when the Fed raises short-term rates. But when short-term Treasury yields rise higher
than longer-term yields, a so-called inverted yield curve, a recession has almost always followed within a year or
Mr. Bostic’s concerns are taking on new urgency because the spread, which compares yields on two- and 10-year
Treasurys, has fallen to levels last seen in 2007. It dropped below 0.3 percentage point last week, down from 0.5
percentage point three months ago and 1 percentage point one year earlier.
“Any inversion of any sort is a surefire sign of a recession,” said Mr. Bostic in an interview last month. “I want us to
avoid being in a situation where” the curve inverts.
Mr. Bostic, an economist, took office one year ago and is a voting member of the Fed’s rate-setting committee this
year. The group has voted to raise rates twice so far this year, both times unanimously, to keep the expanding
economy on an even keel.
While the Fed’s policy shouldn’t focus explicitly on “manipulating the yield curve,” Mr. Bostic said, an appropriate
approach “will be consistent with there not being an inversion.”
His unease is shared by others, including Dallas Fed President Robert Kaplan, St. Louis Fed President James
Bullard and Minneapolis Fed President Neel Kashkari.
The degree of importance others place on the signal could determine whether the Fed raises rates once or twice
more this year.
Fed Chairman Jerome Powell has said the yield curve is important to watch, but he said in March the flatter curve
didn’t appear to be a recession warning.
Inverted yield curves have preceded recessions in part because “inflation was allowed to get out of control, and the
Fed had to tighten, and that put the economy into recession,” he said at a news conference. “It’s really not the
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situation we’re in now.”
Mr. Powell flagged a separate concern: A narrower spread can complicate bank profitability and raise financial
stability risks. Banks pay short-term rates on deposits and earn long-term rates on loans. The prospect that banks
might engage in risky behavior as the spread flattens is an issue “that we’ll be watching carefully,” he said.
Minutes of the Fed’s June meeting released last week showed the debate heated up. The discussion revealed a
willingness on the part of some officials and staff economists to tamp down concerns about the yield spread.
Some officials have said the spread isn’t as reliable an indicator of future growth because bond purchases by the
Fed, the European Central Bank and the Bank of Japan in recent years — designed to spur economic growth by
forcing investors to buy stocks and other riskier assets — have depressed long-term bond yields.
The so-called term premium, or the extra compensation an investor demands for owning a 10-year bond rather
than a shorter-dated instrument, has been slightly negative in recent years, according to one Fed estimate.
A lower term premium “may temper somewhat the conclusions that we can draw” from the historical relationship
between an inverted yield curve and recession, said Fed governor Lael Brainard in a May speech.
Her willingness to consider alternate explanations is noteworthy because last year she was one of the leading
voices for caution in raising rates, citing stubbornly soft inflation. Those concerns faded this year with inflation
returning to the Fed’s 2% target.
Research published last month by Fed staff economists said a more reliable gauge of market-derived recession
probabilities can be found by comparing the difference between the yields on short-term Treasury bills and the
yield implied by futures markets for the same bills some six quarters later.
This measure hasn’t flattened in recent years and implied a low probability of a recession. Boston Fed President
Eric Rosengren said in an interview last month he is paying more attention right now to such measures.
The debate over how much importance to place on an inverted yield curve could grow more fraught in the months
ahead if U.S. economic growth remains strong and global growth falters. That could spur a flight to safe assets
such as long-term Treasurys, pushing long-term yields below short-term yields.
Credit: By Nick Timiraos
Treasuries; Recessions; Economic growth; Yield; Presidents; Economic conditions;
Short term
United States–US Atlanta Georgia
Bullard, James Bostic, Raphael Rosengren, Eric Kashkari, Neel
Company / organization:
Name: Bank of Japan; NAICS: 521110; Name: European Central Bank; NAICS: 521110
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Publication title:
Wall Street Journal, Eastern edition; New York, N.Y.
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Publication date:
Jul 9, 2018
Dow Jones &Company Inc
Place of publication:
New York, N.Y.
Country of publication:
United States, New York, N.Y.
Publication subject:
Business And Economics–Banking And Finance
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