Bond market sends flawed signals on U.S. economy

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Russia’s invasion of Ukraine on Thursday upended financial markets. But, the trading in U.S. bonds is sending flawed signals on the U.S. economy, writes swahapattanaik:

The first warning comes from the gap between two-year and 10-year benchmark U.S. bond yields. This spread has fallen by two-thirds in three months to below 0.4 percentage points and is approaching levels that often serve as early warning of an economic contraction. The second comes from money market prices. They imply that the target fed funds rate, currently at a record low of 0-0.25%, will peak at a little over 2%.

Neither presumption may be reliable. The Fed has been tardy in reacting to the surge in U.S. annual inflation to a four-decade high of 7.5%. And even policymakers who have previously supported a less aggressive stance, like San Francisco Fed President Mary Daly, have recently changed their tune . But rate-setters know that two mistakes won’t cancel out. They will be vigilant for signs of slowing economic growth and ready to slow or pause rate hikes.Meanwhile, investors may be overestimating how easily the Fed can bring U.S. inflation back down. Some forces that have driven up consumer prices, such as supply-chain disruptions, may dissipate, though a reversal of the recent oil-price surge will depend on what happens in Ukraine. Other factors won’t fade away.

The extra uncertainty thrown into the mix by Russian President Vladimir Putin makes forecasting even more difficult than usual. Safe-haven Treasuries have suddenly become more appealing. But that doesn’t mean they are a reliable compass for the future.

 

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