By Stavros Tousios FX Market Specialist, FXPRIMUS
By Stavros Tousios FX Market Specialist, FXPRIMUS

Trimming of the Fed’s optimism

Contrary to 2016, 2017 has been worrisome for bond investors as the steady flattening of the yield curve offers little returns, while the narrowing spread between short and long term Treasuries seems to agonise many analysts too with their 2018 outlooks; a heavy unwavering concern since the 30-10 Year US Yield Spread plummeted to 0.38% only recently, a 2007 record low.

First Published: e-Forex Magazine 79 / Currency Clips / December, 2017

Contrary to 2016, 2017 has been worrisome for bond investors as the steady flattening of the yield curve offers little returns, while the narrowing spread between short and long term Treasuries seems to agonise many analysts too with their 2018 outlooks; a heavy unwavering concern since the 30-10 Year US Yield Spread plummeted to 0.38% only recently, a 2007 record low.

The flattening of the yield curve signals that the Fed has set the Fed Funds rate too high, hence, markets anticipate that future inflation figures are likely to depreciate. Actually, FOMC members have adjudicated to raise twice within 2017, back in June and March respectively. With the last 2017 Interest Rate (IR) decision coming up next week (Dec 13th) the risk for short versus long term Treasury Yield inversion intensifies as analysts foresee, with a 92% majority, that the year-end Fed Funds Rate will increase to 1.50%. In addition, the markets started pricing in 2018 hikes already, which turned, and keeps turning, the short-term Yields to an upward direction. The chart accompanying the text can provides an indication of how closely (normalised) the short and long term Yields are.
 
For the rest of 2017, we saw three good Core inflation figures, five poor and three prints of CPI releases that remained unchanged. Interestingly enough, the five publications included four “steady” and one “better-than-expected”, yet no reductions. Considering a lag of around six months between interest rates and inflation, the March hike should have produced a decrease in inflation in at least one of the last five releases. Regarding Fed’s preferable inflation measure indicator, the core personal consumption expenditures (PCE), its outlook has been slashed down from 1.7% to 1.5%, trimming some of the Fed’s optimism. Taking a peek at the Employment figures,  eight out of the twelve Payroll reports came out worse than the previous, indicating that the Employment sector, and hence the economy, have been growing with a slower pace. Furthermore, from the total of the twelve reports, seven of those were revised downwards, unveiling that economists may have been too optimistic with their projections for another time; the seasonally adjusted revision in over-the-month change 3rd – 2st averaged -24.5K. Since Policymakers rose the 2017 GDP Growth outlook at the latest Summary of Economic Projections back in November, but also in September, most analysts would agree that Fed has been too optimistic about the US economy, increasing their fears for a 2018 Yield inversion.