U.S. Treasurys are signaling trouble for the Federal Reserve Board – trouble that it has brought down upon itself and that it has deliberately imposed on the American public. The market in Treasurys is behaving in ways that suggest a growing expectation of stagflation in the U.S. economy.
The relevant focus is the Treasury yield curve. The yield curve refers to the difference between short-term and long-term interest rates on U.S. Treasury debt. When the economy is expanding, this curve typically has an upward slope. The slope is at its steepest during the earliest stages of the recovery. Eventually, as investors anticipate that the Fed will raise interest rates to stave off inflation, the yield cuve flattens, with short-term rates increasing and long-term rates compressed. Occasionally, the yield curve may even invert, when investors anticipate that the outcome of Fed intervention will be recession.
The U.S. economy is currently recovering. Yet the yield curve, far from flattening, is steepening. The spread between two-year and 30-year Treasury yields last week hit a record four percentage points. The implied annual inflation rate over a five-10 year horizon has now moved up above three percent and towards levels last seen when the Fed’s previous rate-rise cycle began in mid-2004.
In June 2004, the U.S. unemployment rate was 5.6 percent, leaving the Federal Reserve with plenty of scope to tamp down potential inflation by growth-reducing increases in interest rates. In January 2011, the unemployment rate is 9.4 percent. Ben Bernanke must now be perspiring heavily in the expectation of pressure from the White House to run the inflation gauntlet. President Obama surely does not want to enter the 2012 election campaign with unemployment in excess of 10 percent and rising. Nor will the Department of the Treasury relish floating new notes with short-term interest rates in excess of 4 percent per annum.
So stagflation is on the way, as I have warned repeatedly in these columns. Thank you Ben Bernanke for helping to wreck the U.S. economy.