(Bloomberg) -- Federal Reserve Bank of St. Louis President James Bullard cautioned that short-term interest rates may exceed long-term rates by late 2018, creating a so-called inversion of the yield curve that would bode poorly for the U.S. economy.
“There is a material risk of yield curve inversion over the forecast horizon if the FOMC continues on its present course of increases in the policy rate,’’ Bullard, who doesn’t vote on the policy-setting Federal Open Market Committee until 2019, said on Friday in Arkansas. “Yield curve inversion is a naturally bearish signal for the economy. This deserves market and policy maker attention.’’
Some investors and analysts have similar concerns, saying that the narrowing gap between yields on two- and 10-year Treasuries may be a harbinger of a weaker economy. That differential has declined to about 60 basis points from 129 basis points when the Fed began raising rates in this tightening cycle in December 2015.
The case for raising interest rates again in the Fed’s Dec. 12-13 meeting is “coming together,” Jerome Powell, the Fed governor who Trump nominated as chairman, said in congressional testimony this week. That would mark the third hike this year.
But Bullard warned about the risks of continued monetary tightening. “Given below-target U.S. inflation, it is unnecessary to push normalization to such an extent that the yield curve inverts,” Bullard said in prepared remarks. “The empirical evidence is relatively strong’’ that such a reversal reflects the economic outlook. “Therefore, both policy makers and market professionals need to take the possibility of a yield curve inversion seriously.’’
Bullard’s views have sometimes been influential in the FOMC, though in the past two years -- a period during which the Fed has been raising rates -- he has been the most dovish official. In September, Bullard projected no additional Fed hikes through the end of 2019, putting him at odds with the median projection for gradual increases.
Cleveland Fed President Loretta Mester on Thursday played down concerns about the yield curve, instead advocating continued gradual increases in the federal funds rate.
“Long rates are going to go up given where we are in the economy and given where we see the economy going,” she said in an interview. “But this is another reason why we need to keep raising up the short rate. These financial conditions are accommodative.”
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