Bond Yields Send a Disconcerting Signal

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What happened to the four rate increases and the federal funds interest rate rising to 3.5%? Well, it seems that the Federal Reserve was looking at the wrong indicator for signs of “overheating.” The Fed was scope-locked on watching real GDP growth surge to a 4% range instead of watching for signs of benign inflation, which by Fed Chair Powell’s own admission is now below expectations for both its core and headline gauges. The Fed was determined to get GDP growth to “trend,” but its 2.1% growth estimate for 2019 may be in error, especially after U.S. growth surged to 2.9% in full-year 2018.

What would Fed policies have been if the growth trend truly were 3%? GDP growth does not presently seem to be causing inflation pressure, so why not let it run? Here we are now with the 10-year U.S Treasury yield plummeting to 2.51%, the Atlanta Fed’s GDPNow 1Q19 forecast at an abysmal 0.4% and the International Monetary Fund having twice downgraded its 2019 global growth forecast — currently at 3.5% — driven by Europe and China, two of our “Big 3.” The good news is that the United States, the third of the Big 3, continues to get a boost from low tax rates and a pro-business regulatory backdrop; my expectation is for an improved second half of 2019. But for now, low bond yields are sending a dire message.

For an explanation of the Big 3, please see Global Perspectives 2019 forecast, “The Storm before the Calm.”

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