An inverted yield curve should in theory have some negative influence over the economy through the banking system. That’s because banks make money by borrowing at short-term rates and lending it out at long-term ones, and an inverted yield curve should make them less willing to provide funding. But that’s not happening. Fed data show that commercial and industrial loans outstanding have soared by $221.4 billion this year to $2.71 trillion. Not including 2020, when borrowers tapped their credit lines for cash during the early days of the pandemic, this is already the busiest year for lending after 2007’s $235.1 billion, according to data compiled by Bloomberg.
So if not a recession, what’s the yield curve’s message now? Quite possibly, it’s that the current high rates of inflation will be coming down in short order. Breakeven rates on five-year US Treasury notes, which are a measure of what traders expect the rate of inflation to be over the life of the securities, confirm that idea. They have declined to less than 2.70% from as high as 3.73% in March. The outlook among consumers for inflation over the coming years has taken a big drop, according to the latest such survey released by the Federal Reserve Bank of New York this week. Expectations for inflation three years ahead fell to 3.2% in July from 3.6% the previous month in the second consecutive monthly drop.
No doubt the improved outlook has something to do with the recent drop in fuel and food prices after a big run-up. The American Automobile Association says that gasoline prices have fallen almost $1 a gallon since mid-June. The United Nation’s World Food Price Index dropped in July by the most since January. The Bloomberg Commodity Index is down 14% from its high this year on June 9.
The thing to know about the yield curve is that the Fed has tremendous influence over the short end through its ability to push the target federal funds rate higher or lower. It has almost no influence over the long end, which is set by the market and reflects both inflation expectations, the outlook for short-term rates in the future, the supply of bonds and estimates for growth, among other things.
It’s not as if the chief factors that contributed to tame inflation over the past few decades, namely technological innovation and an aging population that favors saving, have gone away. Perhaps the one exception may be globalization. But if we’ve learned anything from the pandemic-era economy, it’s that the old playbooks are largely irrelevant. Nobody predicted with any degree of accuracy what would come after the economy was shut down, some 17 million were booted from the workforce and the government injected trillions of dollars directly into the pockets of consumers and businesses. And we’re still working through the fallout. In that sense, it wouldn’t be crazy to think that perhaps the yield curve has lost its crystal-ball abilities.
Robert Burgess is the executive editor of Bloomberg Opinion. Previously, he was the global executive editor in charge of financial markets for Bloomberg News.