Recession, Inflation, and Yield Curves

After the Fed's latest inflation-fighting interest rate increase, it's time for a Real Simple analysis of Federal Reserve policy:

When the Fed is fighting recession, the federal yield curve is positive; when the Fed is fighting inflation the federal yield curve is "inverted."

What does that mean when it's at home? Well, right now the Federal Reserve Board, Jerome Powell, Chairman, is fighting the inflation that is the consequence of increasing the M2 money supply by 40 percent in 2020 through 2021. So the yield curve on federal debt is "inverted."

The chart from my Federal Yield Curve page shows the interest rate paid on various federal securities from one month (1M) treasury bills to 30-year (30Y) treasury bonds. "Experts agree" that when the yield curve is inverted and short-term rates are higher than long-term rates the alarm bells are ringing for a recession. Just for kicks, here is the yield curve from a year ago.

Hey, no problem! From zero to nearly 5.0 percent on short-term Treasury bills in 12 months! I wonder if that is a world record for raising interest rates. But whatabout the recession? Stocks have been jerking up and down since July 2022 and have been going up since October 2022.

My guess is that right now we have a tug of war between the Fed and the Feds. We have the Fed heroically fighting inflation while the Bidenoids are pedal-to-the-metal on spending. I'd say that the question is whether the Fed's brakes will catch fire first or whether the Bidenoid spending engine will stall out. Get yer tickets here for the All-American Economic Demolition Derby.

Last time out in the 2000s during the lead-up to the Great Recession, the federal yield curve went "inverted" by the end of November 2006. The recession started in the 3rd quarter of 2007, and my blog says that Little Ben Bernanke started injecting "liquidity" back into the economy and lowering interest rates starting in August 2007. By the end of September 2007, the yield curve was positive again, so the Fed was fighting recession. Not very well, as September 2008 proved. Here's how that September went, according to the Wiki timeline abbreviated below (not for the faint of heart).

9/7/2008: Feds take over bankrupt mortgage twins Fannie Mae and Freddie Mac.

9/15/2008: Fed declines to guarantee bad loans at Lehman Brothers; 504.48-point (4.42%) drop in the Dow. Merrill Lynch acquired by Bank of America, helped by the Feds.

9/16/2008: Fed takes over American International Group.

9/17/2008: After a run on U.S. money market funds, Feds provide insurance similar to FDIC.

9/18/2008: Fed requests $700 billion fund to acquire toxic mortgages to avoid meltdown.

9/21/2008: Goldman Sachs and Morgan Stanley convert from investment banks to bank holding companies.

9/22/2008: Japan's MUFG Bank acquires 20% of Morgan Stanley.

9/23/2008: Warren Buffett's Berkshire Hathaway makes $5 billion investment in Goldman Sachs.

9/26/2008: Washington Mutual goes bankrupt and seized by FDIC.

9/29/2008: By a vote of 225–208, U.S. House rejects TARP and Dow drops 777.68 points, or 6.98%

Etcetera. Overall, FDIC says, there were 25 bank failures in 2008. But hey, Warren Buffett picked up a bargain.

Now, as we all know, the 2008 crash was all the fault of greedy bankers. Oh wait. Really, it was the fault of government real-estate mortgage subsidies and promotion of low-down mortgage loans to borrowers with bad credit. Oh, and don't forget the need for the finance industry to cook up derivatives to transmogrify low-rated Fannie and Freddie bonds into Triple-A securities fit to be bought by pension funds.

I wonder what is going on in today's crisis. No doubt there are problems on the real-estate front. No doubt there are all kinds of loans and grants made during COVID that will go bad. No doubt there are financial con artists out there that make lefty youngster Sam Bankman-Fried look like a rank amateur. And then there is green energy and problems on the wind-power front. Will all these problems cause another Great Recession? We don't know, because, as Warren Buffett has said, you don't find out who has been swimming naked until the tide goes out.

Meanwhile you can read articles telling you whatever you want to hear: that there's a bull market immediately ahead, or that the Fed "put," that bails out the losers, is history.

But at least we can be sure that, after it's all over, skinny-dipping aficionado Warren Buffett will have scarfed up a few naked bargains, and Michael Lewis will publish a bestseller on "The Big Short, Part Deux." And blame greedy bankers again.

Christopher Chantrill @chrischantrill runs the go-to site on US government finances, Also get his American Manifesto and his Road to the Middle Class.


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