New York Fed President John Williams said Thursday the flattening yield curve is not signalling a recession, noting that its reputation for predicting downturns may be weaker in the current era of unconventional monetary policy.
Concerns over an inverting yield curve — when longer term bond rates dip below shorter term rates — have built up as the global economy continues to slow. Last month, the yield on the 10-year Treasury fell below levels for the 3-month Treasury bill.
“It’s not telling us we’re about to have a recession,” Williams told reporters on the sidelines of a housing policy conference in New York. “I think what it's telling us is that market participants expect interest rates to be more or less flat, they expect term premium to be pretty low, and they expect growth to be pretty moderate and inflation to be low.”
Williams acknowledged that the Fed’s policy of deliberately flattening the yield curve — by buying longer term Treasurys in “Operation Twist” in 2011 — means that the market interpretation of the yield curve should change.
Other economists have suggested alternatives to the yield curve when looking for a recession, such as the spread between the federal funds rate and the 10-year Treasury. Still, an inversion of the 2-year and 10-year Treasury rates has a strong record; it has predicted all recessions since the 1969 recession.
Also on Thursday morning, St. Louis Fed President James Bullard offered a more dovish interpretation of the yield curve. He noted that the fact that some inversion among some parts of the Treasury yield should be closely watched.
“These market-based signals indicate that the FOMC needs to tread carefully going forward in order to sustain the economic expansion,” Bullard said.
‘I don’t have any worries right now’
Williams said monetary policy is “really well positioned” to handle the U.S. economy at the moment.
In the Fed’s most recent policy setting meeting, the Fed elected to hold rates steady and signaled no further rate hikes for 2019.
Williams acknowledged that the Fed has been below its long-run inflation target, hinting that last year’s concerns over overheating inflation may have been overblown. He said he still expects the U.S. economy to grow around 2%.
“I don’t have any worries right now on financial stability or worries right now about inflationary pressures getting red hot,” Williams said. “So we do have the space to both be patient about our policy stance and also we have the ability to adjust.”
On the balance sheet, Williams said he does not think the gradual shrinking of the balance sheet has “fundamentally changed financial conditions.” The Fed announced in its March meeting that it would begin slowing the pace of its asset holdings runoff in May and then conclude the program at the end of September.
The next FOMC meeting will conclude May 1.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.