Chief economist update: Minutes of concerns

We're all much aware of the US Federal Reserve's optimistic outlook for America's economic growth, unemployment and inflation and that, as per the 13 June FOMC statement, the risks to this outlook "appear roughly balanced."

However, the minutes of the 12-13 June FOMC meeting indicates that the risks are leaning a bit heavier on the downside.

There's the risk from Trump's protectionist policy and then there's the risk that the expansionary fiscal policy - tax cuts and infrastructure spending - won't be sustainable.

"Most participants noted that uncertainty and risks associated with trade policy had intensified and were concerned that such uncertainty and risks eventually could have negative effects on business sentiment and investment spending. Participants generally continued to see recent fiscal policy changes as supportive of economic growth over the next few years, and a few indicated that fiscal policy posed an upside risk. A few participants raised the concern that fiscal policy is not currently on a sustainable path. Many participants saw potential downside risks to economic growth and inflation associated with political and economic developments in Europe and some EMEs."

There's concern over the flattening yield curve. The yield differential between the 10Y US Treasuries and the 2Y bonds is now down to 28 basis points from 54 bps at the start of the year. This is lower than the 73 bps gap that prompted then Fed Chairman to deliver his "interest rate conundrum" speech in testimony before the US Senate Committee on Banking on February 17, 2005.

If I recall correctly, rising US short rates and steady to falling long-term rates were attributed to the global savings glut at the time, that were into US 10-year Treasuries, keeping their yields low.

'Twas a logical explanation at the time and is more or less is along the same line that current Fed Chairman Jerome Powell used - he claims that short term rates are rising because of the hikes and the smaller lift in the long-term yields to safe-haven buying.

The FOMC minutes revealed that "participants" discussed the flattening yield curve at the June meeting - some were concerned, others tried to explain it away.

"Some participants noted that such factors might temper the reliability of the slope of the yield curve as an indicator of future economic activity; however, several others expressed doubt about whether such factors were distorting the information content of the yield curve.

A number of participants thought it would be important to continue to monitor the slope of the yield curve, given the historical regularity that an inverted yield curve has indicated an increased risk of recession in the US."

And rightfully so. The picture below paints it better than 1000 words:

But perhaps, a more logical explanation these days is that financial markets are putting their money on the Fed's growth forecasts. Rapid and solid growth now - GDP predicted to grow at 2.8% this year - before slowing to 2.4% in 2019 and 2% in 2020.

Add in safe haven purchases of US Treasuries - due to trade concerns, emerging market concerns and higher than expected US inflation in the near term (because of tight labour market) that could prompt a more aggressive Fed - and indeed, it looks safer further out the curve.

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a fund manager, economist, asset allocation strategist, portfolio analyst and stock market analyst. Check out his economics analysis here.

Read more: June FOMCMinutes of10Y US TreasuriesAmericaBankingcurrent Fed Chairman Jerome PowellEuropeTrumpU.S. Senate CommitteeUnited StatesUS Federal Reserve
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