Holding to the Old Faith
Figure 1: Ten year-3 month Treasury yield spread (bold dark blue), and ten year-two year Treasury yield spread (bold dark red), and projections at current pace using 2017M01-18M08 sample (light blue and pink lines), in percentage points. August 2018 observation through August 27th. NBER defined recession dates shaded gray. Light orange denotes Trump administration. Source: Federal Reserve Board via FRED, Bloomberg, NBER, author’s calculations.
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With the election, and anticipation of a large fiscal impulse (tax cut, infrastructure spending), the dollar rose and the term spread increased. As expectations of the latter disippated, both the dollar and spread shrank. But recently, the comovement has broken down.
Nominal asset prices, including S&P500 and home, continue to rise, but real prices have not regained prior levels (S&P500) or have plateaued (home prices).
Trending down.
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That’s a new article at the outstanding web portal VoxEU, coauthored by Matthieu Bussière, Menzie Chinn, Laurent Ferrara, and Jonas Heipertz, and based on this paper:
The ‘Fama puzzle’ is the finding that ex post depreciation and interest differentials are negatively correlated, contrary to what theory suggests. This column re-examines the puzzle for eight advanced country exchange rates against the US dollar, over the period up to February 2016. The rejection of the joint hypothesis of uncovered interest parity and rational expectations still occurs, but with much less frequency. In contrast to earlier findings, the Fama regression coefficient is positive and large in the period after the Global Crisis, but survey-based measures of exchange rate expectations reveal greater evidence in favour of uncovered interest parity.
Down, down, down. 10yr-3mo at 0.86% at 2pm today. See Jim’s post for more on the spread.
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Several people have asked me if the flattening yield curve is a warning of impending weak growth or even a recession. My answer is not yet. Here’s why.
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First, look at futures as of today (with the decline looking unabated):
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Today, the 10 year-3 month spread ended below 1%, in the absence of safe haven effects. The 10 year-2 year spread ended at 0.35%.
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