Foreword
This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.
As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.
If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.
Curve inverted
Historically, when the US Treasuries yield curve inverts, such that 2 year Treasuries have a higher yield than the 10 year Treasuries, recession very often follow within about 18 months. Therefore, you can imagine the concern in various financial forums when the 2/10s inverted late last week, and the inversion got even worse (2 year Treasuries yield – 10 year Treasuries yield became bigger) this week.
Separately, the thinking is that the Federal Reserve generally has greater control over the short end of the curve (i.e. the Fed can influence 2 year yields more than they can influence 10 year yields). Hence the inversion suggests that the Fed may have to stop their rate hiking cycle before it really got out the door, for fear of making the inversion even worse.
Brainard to the rescue
Today, Lael Brainard, Biden’s proposed vice chairperson of the Federal Reserve, also historically one of the biggest doves (in favor of lower rates) in the Fed, made a speech. In that speech, she shed her dovish skin, and made the case not just for greater rate hikes, but also for faster Quantitative Tightening (QT), possibly as soon as early May.
Conventional wisdom (as covered above) would suggest that such hawkishness from one of the traditionally more dovish members of the Fed, and also someone with considerable influence due to her pending appointment to vice chair, would cause rates to rise, and the inversion to get worse.
Conventional wisdom was half right. Yields across the curve jumped around 10bps (0.1%), but the curve un-inverted. 2 year Treasuries are now yielding less than 10 year Treasuries, albeit by a tiny amount (about 2 bps) — 10 year yields jumped more than 2 year yields due to Brainard’s speech.
What would the Fed make of this, I wonder? And how would they react? Would they be encouraged to hike even faster?
Janky Thoughts 