Which is Worse?
All weekend long I saw a lot of news that basically boiled down to one question – which is worse, a yield curve that is flattening or bond yields that are going up?
When the Fed raises interest rates (by raising the federal funds rate), they are signaling that they have faith in the economy. They are also giving themselves the necessary room to fight the next recession by lowering interest rates.
I think the Fed is right where it needs to be on this issue…they are not ahead of the game nor are they behind it. Most economists are expecting the 10-year to end up between 3.00-3.50%.
Rates generally increase because things are looking good out into the future.
What about the yield curve? This is the difference between the yield on the 10-year treasury and the 2-year treasury. Subtract the 2-year yield from the 10-year yield and if the number is positive, the curve is “positive”. When it goes negative it is a very good predictor of a recession. The math is currently showing a positive yet shrinking number. People are extrapolating that the direction down to negative will continue.
When the number is small, it is said that the curve is “flat” or “flattening”. Yet despite a flat U.S. yield curve, there is no recession in the global economy according to commodity prices – In fact, oil and other commodity prices are going UP. I think it’s remarkable that oil prices are soaring given U.S. and Canadian oil output.
The flat curve means that the Fed is probably doing the right thing at the right time. They’re trying to keep a lid on inflation. If they were behind that mandate, the curve would be steep.
What do stock investors want? They want the Fed to stop raising the federal funds rate. But let’s be real – that’s simply not going to happen. The Fed needs to have room to lower rates to forestall any future recession.
I see this as good for stocks over the long run and the Fed’s ongoing tightening substantiates that the economy is strong enough to absorb the gradual increases.
It’s hard to “fight the tape” right now, but with over 150 companies done reporting, 80% have beat their earnings estimates for the first quarter of 2018. According to Bespoke, that number has not been seen in over 20 years! That’s much more instructive to me than trying to determine which is worse…because I think earnings eclipses it all.
Keep looking forward,
Dave
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David B. Armstrong, CFA
President & Co-Founder
Dave got into the industry when he discovered his passion for finance in his mid-20’s. He’s a combat veteran and served as an officer in the United States Marines Corps on both active duty and in the reserves, retiring at the rank of Lieutenant Colonel. While serving on active duty, Dave was unable to spend money on deployments, so he became a self-taught investor. Along with a few bucks cash as a bouncer, his investing performance grew to be good....
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