A just-published report examined one of the most debated areas of market research/opinion, namely what is the current message from the U.S. yield curve? In truth, there are various yield curves, with the traditional 2/10 year yield curve widely seen as signalling problems ahead, yet the more reliable yield curve using shorter-term yields is signalling the opposite. The 2/10 year yield curve provided a very misleading (or extremely early) recession/weak growth signal in the mid-1990s, and we expect a similar miscue this cycle.
The conflicting yield curve messages have been driven by distortions in monetary policy and QE, combined with lingering secular stagnation worries. There is still an entrenched view that underlying inflation will return to 2% before too long, partly because bond yields and the policy rate cannot rise very much without undermining the economic expansion.
The report provided a framework on how to interpret movements in various parts of the yield curve, and outlined where we see distortions at this juncture. The bottom line is that we anticipate that the fed funds rate (and bond yields) will rise more than is currently discounted over the cycle, and remain cyclically bearish on bonds.