Why Yields Have Done Nothing Despite Five Fed Rate Hikes

By Bryan Rich

December 14, 2:19 pm EST

The Fed decided to hike interest rates by another quarter point yesterday.  That was fully telegraphed and anticipated by markets. That’s the third rate hike this year, and the fifth in the post-crisis rate hiking cycle.

Still, the yield on the 10-year Treasury note (the benchmark market determined interest rate), moved lower today, not higher — and sits unchanged for the year.

We talked earlier in the week about the biggest central bank event of the month. It wasn’t the Fed, but it will be in Japan next week.  Japan’s policy on pegging their 10-year yield at zero has been the anchor on global interest rates.

When they signal a change to that policy, that’s when rates will finally move.

With this divergence between what the Fed is doing (setting rates) and what market rates are doing (market-determined), people have become convinced that the interest rate market is foretelling a recession coming — i.e. short term rates have been rising, while longer term rates have been quiet, if not falling. For example, when the Fed made it’s first rate hike in December of 2015, the 30-year government bond yield was 3%. Today, after five rate hikes on the overnight Fed determined interest rate, the 30-year is just 2.72% (lower, not higher than when the Fed started).

This dynamic has created a flattening yield curve.  That gets people’s attention, because historically, when the yield curve has inverted (short term rates rise above long term rates), recession has followed every time since 1950, with one exception in the late 60s.

And it turns out, this “flattening of the yield curve” indicator, historically (and ultimate inversion, when it happens), is typically driven by monetary policy (i.e. rate hikes — check).  In these cases, the market anticipates the Fed killing growth and eventually leading rate cuts!  They find more certainty and stability in owning longer term bonds (leaving short term bonds pushing those rates up and moving into long term bonds, pushing those rates down — inverting the curve).

The question, is that the case this time?  Or is this time different.  It’s rarely a good idea in markets to think this time is different than the past. But in this case, following trillions of dollars of central bank intervention and a near implosion in the global economy, it’s probably safe to say that this time is certainly different than past recessions.  Though the Fed is in a hiking cycle, rates remain well below long term averages. And, as we know, we have unconventional monetary policies at work in other key areas of the world — stoking liquidity, growth and skewing demand for U.S. Treasuries (which suppresses those long term interest rates).

So the flattening yield curve fears are probably misplaced, especially given big fiscal stimulus is coming.  And when Japan  moves off of its “zero yield policy,” the U.S. yield curve may steepen more quickly than people think is possible.

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