US headed for another recession? Fed underplays flattening yield curve

As the gap between short- and long-term borrowing costs hovers near its lowest in more than 10 years, speculation has risen over whether the so-called yield curve is signalling that a recession could be around the corner.

Not to worry, two influential Federal Reserve policymakers said on Friday. Another, whose views are typically outside the mainstream at the Fed, disagreed.

Growth prospects look pretty strong, which is why the Fed is raising short-term interest rates, the two sanguine policymakers explained. Those rate hikes, they said, are in and of themselves acting to flatten the yield curve.

In addition, they argued, the curve will likely steepen as the US government runs a bigger deficit and issues more debt, they said.

The calming comments, from the New York Fed's incoming chief John Williams and from Chicago Fed President Charles Evans in back-to-back but separate appearances, appeared calculated to allay concern about a potential slowdown ahead.

"The yield curve is not nearly as much of a concern as I might have pointed to a couple months ago," Evans said in Chicago after a speech, in response to a reporter's question.

Williams, who will leave his current job as San Francisco Fed president in June to take over at the New York Fed, also said he expects the Fed's shrinking balance sheet will help steepen the curve by putting upward pressure on longer-term rates.

In January the US Congress passed a budget deal that boosts US government spending, following a December tax package that slashes corporate tax rates. Both changes are expected to lead to an increase in government borrowing in coming years.

The Fed policymakers reason that a bigger supply of debt should put downward pressure on Treasury prices and deliver a corresponding lift to yields.

"We've got more fiscal debt in train in the US That has to be funded," and will likely push up long rates and steepen the yield curve, Evans said.

At their March meeting, Fed officials "generally agreed that the current degree of flatness of the yield curve was not unusual by historical standards," according to the meeting minutes.

Since then, longer rates have come closer to being overtaken by short rates, a phenomenon known as yield curve inversion, which has been a reliable precursor of past recessions.

Still, there is debate within the Fed over whether a flat yield curve is problem.

Dallas Fed President Robert Kaplan earlier this week said that while the Fed has flexibility to raise rates now, the 10-year yield imposes limits on how far it can do so. The 10-year yield on Friday was at 2.96 percent, the highest in more than four years.

Minneapolis Fed President Neel Kashkari, who consistently voted against rate hikes last year, said in a CNBC interview on Friday that the flattening curve was "a yellow light flashing," a warning that the Fed should soon stop raising rates or risk braking the economy too quickly and plunging the country into recession.

Evans, who joined Kashkari in dissenting last December but who earlier this month has sounded more supportive of gradual rate hikes as the economy strengthens, isn't buying it.

"Any concerns that we may have expressed before about an overly flat yield curve, I'd put off to the side until we see things play out."