Tuesday, September 6, 2011

The Yield Curve Can’t Invert With Fed Manipulation

I have heard otherwise intelligent people say that the economy can’t go into a recession because the slope of the Treasury yield curve is too positive.

With the Fed trying to manipulate the yield curve for its own policy purposes, starving savers of income, the yield curve is not a useful measure. To invert the Treasury yield curve when the Fed is holding short rates at zero, we would have to see the Fed engage in Quantitative Easing to the degree that Treasury Notes and Bonds can be issued at significant negative interest rates.

To argue that we can’t have a recession at present because of the Treasury yield curve essentially says that if the Fed holds short rates at zero, we can’t have a recession.

I’m sorry, but with an overindebted economy, we can have a structural, not cyclical recession, where the shape of the yield curve doesn’t matter much because of all the debt. When large portions of the economy have no inclination to borrow, monetary policy, even unorthodox and evil monetary policy has little effect on the real economy, where ordinary people borrow money (excluding from the GSEs).

This is another reason why I think the Fed actions to twist the yield curve will fail. They can twist the curve, yeah, but it will do little to stimulate an overindebted economy where many mortgage loans are inverted.

The Fed may control the Treasury yield curve, but it does not control the free market yield curve where (aside from Fannie and Freddie and the FHA), ordinary people and firms borrow.