Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / What the Steep Yield Curve Is Telling the Fed
Transcript
- Lucas: So the 10-year Treasury yield hit 4.68 percent this week — that's up more than two percent in the last five days alone, and the spread over the 13-week T-bill is now about 87 basis points. That's the steepest positive slope we've seen since early 2023. Luna: And that's a stark change from just a year ago when everyone was obsessed with the inverted curve. Now it's all about what the steepening means. Lucas: Exactly. The inversion was supposed to signal a recession. Instead, the economy kept humming. Now the curve is telling a different story — maybe about future growth, but also about something else: term premium. Luna: Term premium — the extra yield investors demand for holding long-term bonds over rolling short-term ones, right? Lucas: Right. And the term premium has been unusually low for years. But now it's creeping back. The New York Fed's ACM model shows the term premium on the 10-year is around 30 to 40 basis points, up from negative territory in 2020. That's a big shift. Luna: So what's driving that? Is it inflation expectations? Because the 10-year breakeven is only 2.26 percent — that's actually down a bit. Lucas: That's the puzzle. Inflation expectations are well anchored. But the bond market is still demanding more compensation. Most likely it's about fiscal uncertainty — the deficit is still large, and the Treasury keeps issuing at the long end. Investors want a bigger cushion. Luna: Meanwhile, the Fed is sitting at 3.63 percent on the effective rate and has been on hold since June. The economy is growing at 2.1 percent annualized, unemployment dropped to 4.2 percent, jobless claims are at 187,000 — very low. So why aren't they cutting? Lucas: That's the million-dollar question. The Fed's mandate is maximum employment and price stability. Employment looks solid. Core PCE is still at 2.1 percent year-over-year if you annualize from the last reading. They're close to target, but they want to be sure. Luna: And the low jobless claims — 187,000 is historically extremely tight. That suggests labor market still has slack? Actually, it's the opposite: there's very little slack. Lucas: Right. So the Fed is in this awkward spot: growth is above trend, labor market tight, but inflation is cooling. Normally you'd cut rates to avoid overshooting on the downside. But the steep yield curve might be giving them cover to hold tight.