St. Louis Fed’s Bullard Addresses the Risk of Yield Curve Inversion

Federal Reserve Bank of St. Louis President and CEO James Bullard

Yield curve continues to flatten and, under some scenarios, could invert over the forecast horizon, Bullard says at Regional Economic Briefing in Little Rock, Ark.

Federal Reserve Bank of St. Louis President James Bullard gave remarks on “Assessing the Risk of Yield Curve Inversion” at a regional economic briefing in Little Rock on Friday.

In his talk, Bullard addressed the possibility of a U.S. Treasury yield curve inversion in the near term if the Federal Open Market Committee (FOMC) continues on its current higher projected path for the Federal Reserve’s policy rate (i.e., the federal funds rate target). He noted that an inverted yield curve (which occurs when yields on shorter-term government debt exceed yields on longer-term government debt) is often considered a predictor of recessions.

“There is a material risk of yield curve inversion over the forecast horizon if the FOMC continues on its present course of increases in the policy rate,” Bullard said. “Yield curve inversion is a naturally bearish signal for the economy. This deserves market and policymaker attention.”

He also discussed two possible ways to avoid an inverted yield curve—rising longer-term rates and policymaker caution. “It is possible that yield curve inversion will be avoided because longer-term nominal yields will begin to rise in tandem with the policy rate, but this seems unlikely as of today,” he said. “Given below-target U.S. inflation, it is unnecessary to push normalization to such an extent that the yield curve inverts.”

A Flattening U.S. Yield Curve that Could Invert

Bullard noted that the U.S. nominal yield curve has been flattening since 2014. While the spread between 10-year and one-year Treasury yields was nearly 300 basis points in early 2014, the spread has narrowed recently to 73 basis points.

“The FOMC has been increasing the policy rate over the last year, and thus shorter-term interest rates have been rising. At the same time, longer-term interest rates in the U.S. have not changed very much,” he explained.

He then speculated what might happen if longer-term yields remain near their average since 2012 and if the FOMC…

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