A key indicator points to a strong 2018. That's the risk.
Bloomberg|
Updated: Nov 21, 2017, 11.51 PM IST
If this year’s economy has been kind to you, signs are good for your 2018 as well. This isn’t just some goldilocks view of the world. And I know it doesn’t match the doom and gloom generally associated with economics the past decade. (Don’t forget that a year ago it was still en vogue to mouth generalities about a disappointing recovery, mediocre growth and associated ills — a view that was wrong.) This more optimistic picture is painted by the US government bond yield curve – which is not so curvy these days. Gross domestic product has waxed and waned the past few years, but the downward drive in unemployment has been remarkably consistent.
The curve refers to the difference between yields of short-term securities sold by the Treasury and those of longer-dated maturities. Typically, yields on longer-term bonds are higher than those of shorter maturity, reflecting an over-the-horizon outlook for inflation and reflecting that the Federal Reserve, when it acts, has the most direct influence at the short end. Lately, the gap between the two has been narrowing. In market parlance, the curve has been flattening. Whenever this happens, it’s generally accompanied by predictions of a slowdown.
But this time, there’s a backdrop of synchronised global growth, low unemployment and some capital spending by businesses. In some ways, the flattening is nothing more than what you would expect when the Fed is raising rates, even if this cycle of increases isn’t particularly aggressive. As Roberto Perli of Cornerstone Macro points out, the curve has flattened in five of the six Fed tightening cycles since 1984. So far, so good. No cause for alarm that anything unprecedented is afoot.
The Fed raised rates twice this year and will probably do so again next month, basically what it said it would do. Three more are pencilled in for 2018, according to central bank projections. And as we know, inflation has been missing in action – despite very solid economic growth in the US, Europe and Asia. The Fed is still taking things carefully. So the yield curve is behaving as it should.
Another year like 2017 wouldn’t be too shabby, especially given the pessimism that has surrounded the economy for most of the period since 2009, when it began emerging from recession. It’s even worth considering whether next year could be an even stronger year. And that’s, just conceivably, the potential bad news in the yield curve.
The unemployment rate could well push even lower. Gross domestic product has waxed and waned the past few years, but the downward drive in unemployment has been remarkably consistent. It started the year at 4.8% in the US and fell to 4.1% in October. That’s already the level it’s supposed to be at the end of 2018, according to forecasts by economists surveyed by Bloomberg News.
The curve refers to the difference between yields of short-term securities sold by the Treasury and those of longer-dated maturities. Typically, yields on longer-term bonds are higher than those of shorter maturity, reflecting an over-the-horizon outlook for inflation and reflecting that the Federal Reserve, when it acts, has the most direct influence at the short end. Lately, the gap between the two has been narrowing. In market parlance, the curve has been flattening. Whenever this happens, it’s generally accompanied by predictions of a slowdown.
But this time, there’s a backdrop of synchronised global growth, low unemployment and some capital spending by businesses. In some ways, the flattening is nothing more than what you would expect when the Fed is raising rates, even if this cycle of increases isn’t particularly aggressive. As Roberto Perli of Cornerstone Macro points out, the curve has flattened in five of the six Fed tightening cycles since 1984. So far, so good. No cause for alarm that anything unprecedented is afoot.
The Fed raised rates twice this year and will probably do so again next month, basically what it said it would do. Three more are pencilled in for 2018, according to central bank projections. And as we know, inflation has been missing in action – despite very solid economic growth in the US, Europe and Asia. The Fed is still taking things carefully. So the yield curve is behaving as it should.
Another year like 2017 wouldn’t be too shabby, especially given the pessimism that has surrounded the economy for most of the period since 2009, when it began emerging from recession. It’s even worth considering whether next year could be an even stronger year. And that’s, just conceivably, the potential bad news in the yield curve.
The unemployment rate could well push even lower. Gross domestic product has waxed and waned the past few years, but the downward drive in unemployment has been remarkably consistent. It started the year at 4.8% in the US and fell to 4.1% in October. That’s already the level it’s supposed to be at the end of 2018, according to forecasts by economists surveyed by Bloomberg News.
