A couple of policymakers disagreed on how to interpret recent flattening of the U.S. Treasury yield curve. Kashkari argued that it meant inflation expectations might be drifting lower (Dec 19). While Kaplan also thought “The history of inversions is such that it has tended to be a pretty reliable forward indicator of recession,” he also thought that “this time might be different,” although he “wouldn’t count on it” (Dec 19). In his view, “it limits the Fed’s operating flexibility, in my judgment, in terms of how fast and how much we can raise rates.” His overarching concern appeared to be the risk of falling behind the curve: “We are already at or near full employment now. I believe we’re going to overshoot full employment in the next year…The degree of the overshoot is such my concern is that if we wait too long to remove inflation, we’re going to be playing catch-up.” Earlier, Yellen had said that “the flattening yield curve mainly reflects higher short-term rates” and noted that “the current slope is well within its historical range” (Dec 13). She warned that “there are good reasons to think that the relationship between the slope of the yield curve and the business cycle may have changed.” She cited a “zero term premium” as a possible reason behind yield curve inversion. As such, “it could more easily invert if the Fed were to even move to a slightly restrictive policy stance you could see an inversion with a zero term premium.”
The White House’s nominations for the Federal Reserve Board remain in progress. The President must resubmit the nominations for both Goodfriend and Powell in 2018, as the Senate ended its 2017 session without voting. For Powell, we don’t see this obstacle as much of a hurdle, as the Senate Banking Committee had already opted to advance his nomination.