The 10yr/2yr yield curve put in its flattening cycle low over a year ago and has been on a grinding steepener ever since. Long before the…
…reared its ugly head the August 2019 inversion and more importantly the subsequent steepening had begun to forecast economic problems to come.
Now, would the steepener be under pains of inflation or deflation?
Ah yes, a simple black or white question. Well so far it has been under pains of both. Since March inflation has been the controller as long-term interest rates rise more than short-term interest rates, inflation expectations rise and the Fed pump pump PUMPS the economy full of (funny) munny created out of nowhere. The big spike in March? Err, deflationary, as frightened casino patrons followed the machines, knee jerking to the liquidity of short-term government bonds.
I can’t say whether the dominant driver of this new steepening phase will turn out to be inflation or deflation, but I can say that either would drive the yield curve higher. At worst that means the economy and levered financial system attached to it are in big trouble. At best it means that growth will be inflationary as per the 2003-2008 macro phase. Thing 1 would seek to purge the system now. Thing 2 would do so after the inflationary exercise in greed plays out (e.g. 2008’s resolution of the phase that began in 2003).
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