E The Bond Market Is Calling The Fed's Bluff

Something happened Tuesday that we haven't seen since December 2007. . .

The spread between Treasury bills due in 5 years and the 30-year collapsed. It went as low as 96 bips, or less than 1%.

The 30-year rate is most influenced by inflation expectations. When creditors loan money out for three decades, they need to have an idea of what their nominal and real returns will be.

The yield curve is flattening as bond investors buy longer term paper. And the last two times this happened, the economy entered recession.

Today it is signaling deflation and recession yet again. . .

Why? What's going on?

The Fed's hawkishness and rush to hike is contrasting weakening inflation.

Data last Wednesday showed that the so-called core Consumer Price Index i.e. CPI, which strips out food and energy costs, increased 1.7 percent year-on-year in May, the smallest rise since May 2015 - wrote Reuters.

Chicago Fed President Charles Evans, spoke on Tuesday in an interview that he is worried about recent inflation softness. He is skeptical the Fed will even reach and maintain its 2% inflation objective. Evans also made the bold statement that if inflation stays soft, they will have to reduce hiking aggressiveness.

"I will say that the most recent inflation data made me a little nervous about that. I think it's much more challenging from here on out," Evans said in an interview with broadcaster CNBC.

It appears that the market does not believe the Fed's pro-growth hype. . .

In fact, the more the Fed boasts this extremely aggressive hawkish message, the more longer term yields continue to fall.

wrote last week that this current pace of deteriorating economic growth, coupled with a hiking and unwinding Fed, will lead to inversion. And it appears today the market is nearing that outcome.

Yields have to be flat first before they can invert.


Softening inflation is only just a symptom of a deeper problem. Weaker credit growth is at the root.

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Gary Anderson 2 years ago Contributor's comment

Great article. Makes the inflation hawks continue to look silly.