This is a cynical take, but it's an honest good faith effort on my part. I post a thorough comment in hopes that people can build on top of or destruct where it's wrong.
> The Federal Reserve has two mandates: maintaining maximum employment and maintaining stable prices and moderate long-term interest rates.
This seems fine at first glance, until you see that maximum employment does not mean maximum employment, and in fact you can have more than maximum employment. Last decade we had more than maximum employment and the Fed was expecting inflation that did not come. "Struggling to reach 2%".
Why was the Fed expecting inflation? Because when you have more than full employment, it converts the labor market from a buyer's market to a seller's market. This ties in with the other side of it's mandate: stable prices. Why would prices rise? If you read my water analogy comment[0], you could see that there are only two real ways. The rivers are higher, or the reservoirs are leaking. We have not seen any signs of reservoirs leaking.
So then the rivers are higher. What is the CPI really tracking? What is the Fed trying to keep under control? The ability for labor to negotiate. Why did we not get inflation even though we had above maximum employment? Wealth inequality. Monopolies. The business owners have all but shut down a perfect competition in the economy and can without discussing openly, act like a cabal.
Until CO-VID, until unemployment checks, until stimulus going out to people. Suddenly labor has an opportunity to negotiate. People are leaving their jobs and moving to higher paying ones. Work from Home is having companies compete from all over the nation, now you are not limited by your building size, you can employ as much as you can handle. Wages are being negotiated. Suddenly it's a seller's market.
So the rivers are rising. The Fed has to react according to their mandate. What will they do? The same thing they have done the last 8 times since the 70's, they rise rates. It's a proven strategy that when the Fed funds rate rises above the 30 year treasury rate[1], it de-stabalizes the economy. As a result within short order we get a recession. Recessions mean job losses, which means the market moves back to a buyer's market. Labor is happy to have any job at all. The rivers fall. Inflation is back off the table. Once the goal has been reached and the market has switched, they go ahead and drop the interest rates back down to 0. Let the free money be free once again.
So long as it does not cause disruptions? Disruptions for whom? To me it looks like the system is working exactly as it was designed.
> It's a proven strategy that when the Fed funds rate rises above the 30 year treasury rate, it de-stabalizes the economy.
No, its proven that when investors are skittish about the private markets, which is both a predictor and contributor to recession, their seeking the shelter of Treasuries causes the usual coupling between general interest rates and Treasury rates to break in the direction of lower Treasury rates.
You have reversed cause and effect. It is not that inverted yield curve causes economic instability. Economic instability, and the market response to it, causes an inverted yield curve, and tends to do so before the point at which a “recession” is labelled.
The market doesn't set the Fed Funds Rate, the Fed does. If we were simply talking about the other yield curves I would be on board with this argument. But the Fed is in total control. Why, if the Fed was seeing a recession coming, would they raise rates? How does that make sense?
It sets the Treasury yield, though, and it usually follows the direction of Fed Funds rate changes, because higher general interest rates means loaning money to the government at low rates makes less sense unless you really don't trust the private market to pay off.
> But the Fed is in total control
No, the Fed does not set Treasury yields.
> Why, if the Fed was seeing a recession coming, would they raise rates?
Yield inversion don't tend to follow Fed rate increases, but drops in the Treasury yields which the Fed does not set. Because, again, it has nothing to do with Fed policy, it is a product of breakdown in confidence in the private market which leads to a sharp increase in the risk premium charged to private market investments by investors.
The Fed is in complete control of the Fed Funds rate. Whenever they set for the target, they hit it. Can we at least agree on that?
Look at the chart I posted above. 1969, 1973, 1979, 1989, 2000, 2006. All of these are a case of the Fed Funds rate being raised above the 30 year.
Only in 2019 do we see a Treasury yield falling into the rate, but they did snuggle up to allow that to happen.
I think you are confused because normally when people talk about the yield curve, they are looking at the 3mo-10yr treasuries. I'm not here. I'm comparing between the Fed Funds Rate and the 30 year. This is another form of a yield curve. The shortest duration to the longest duration. This curve, if the Fed wishes, never has to invert. They can always step in and react and get it to not invert. And yet, 6 months before every recession in the past 50 years, it inverted.
> Look at the chart I posted above. 1969, 1973, 1979, 1989, 2000, 2006. All of these are a case of the Fed Funds rate being raised above the 30 year.
If you chart the Fed Funds target rate (or the upper and lower limit of the target range; the data available is different at different times, because the former series was discontinued in favor of the upper/lower limit series) and zoom in, you’ll see several things:
First, the Fed did not raise target rates above the 30yr yield, it raised it near the 30yr yield, then the yield fell through.
Second, there are lots of other cases (both distant from and just prior to inversions) where the Fed raised target rates close to the 30yr yield, and (as expected) the interest rate hike just drove the 30yr yield higher. This is consistent with what I said: yield inversions happen when the market loses faith in private sector investments, increasing the risk premium relative to government debt and dropping yield on Treasuries relative to general interest rates.
The Fed Funds Rate (barring unusual perception of private market risk) and Treasury yields are both perceived as near risk free rates available to overlapping sets of investors; the law of one price suggests that as long as that unusual risk perception is absent, they should track close, and they do.
> I think you are confused because normally when people talk about the yield curve, they are looking at the 3mo-10yr treasuries. I'm not here. I'm comparing between the Fed Funds Rate and the 30 year
I think you are confused because you are looking at the effective Federal Funds rate (set by the market, but responding to changes to the target rate) instead of the target rate, and zoomed out to far. The story doesn't change much if you look at the 10yr yield (its a little different with shorter terms).
> They can always step in and react and get it to not invert.
But why would they?
There's no decent explanatory theory for any of the yield curve inversions causing a recession. There are very good theories for why they tend to be produced on the way into recessions. So they are decent recession signals, but not things you can stop a recession by preventing. (And, yes, there's a feedback argument that any known signal can be a cause, but the Fed can't visibly intervene to short-circuit that, because that intervention sends the same market signal, earlier, as the thing it seeks to prevent.)
Let's zoom in on this most recent case[0] where it was the treasury came down. We can see that there is a point where the 30 year was not only below the upper bound of the target rate, not only below the effective rate, but below the lower bound. We can see that the effective rate almost always stays within the bounds, and only moves outside of the bounds right before the Fed is about to move rates. As they give dot plots signalling that they are about to move rates, this makes sense. The market is simply smoothening out the transition.
Let's look at more yields[1]. You want to get a feel for how they work with each other. An easy way to understand it is through a dog-leash analogy. The Fed funds rate has no leash. When they move it, it moves. When they move it the 30 year does what it wants, it's a very long leash. The 3 month? It's got a short leash and therefore mostly tracks against the Fed funds rate. The 10 year is, as you can see, mostly in between those two extremes.
> There's no decent explanatory theory for any of the yield curve inversions causing a recession.
I agree with you here, that there is no economics research papers directly showing A -> B. But there was also no science showing that smoking causes cancer until decades later, and still very little science that proves that sugar causes weight gain. I'm not saying we can't trust research, but we should look at what research is being funded and by whom. Is the sugar studies funded by Kellog's and Nestle? At the very least this is a large enough topic that there should be significant negative papers being released, but I have not seen any. If you could link them, I would appreciate it.
We know what happens when the Fed brings rates up too high. We know that by not reacting during the Great Depression they made it worse. I don't think it's an unbelievable stretch to question that Fed funds above 30 year treasury causes recessions.
I'm a programmer and spend a great deal of my time trying to understand systems. I have a feel of how chaos occurs when one fundamental thing is wrong, it causes many small issues that is often very tricky to point it back to that one thing. My intuition is tingling. To me it's obvious that the Fed caused the 2008 recession by raising rates in 2006 causing the adjustable rate mortgages to default, and the housing market was simply the biggest naked swimmers, just as the S&L crisis was the biggest naked swimmers in 87. We've got naked swimmers today, and they'll be blamed once again, but it was always the Fed.
The "clearing" interest rate balances supply and demand for labor. That's unfortunately not the same thing as full employment.
When supply shocks reduce the availability of energy it can also result in a reduction in the supply of labor because people cannot work. Setting the interest rate correctly means that everyone who can work and wants to work gets to work.
>and the Fed was expecting inflation that did not come. "Struggling to reach 2%".
>The ability for labor to negotiate. Why did we not get inflation even though we had above maximum employment? Wealth inequality. Monopolies. The business owners have all but shut down a perfect competition in the economy and can without discussing openly, act like a cabal.
Inequality is driving the demand for labor down, i.e. rich people are saving money at a faster rate than the rest of the economy can spend it. This forces inflation and interest rates down. When the economy is controlled by increasingly fewer people who already have everything they could possibly want then your economy will slowly reach saturation because these individuals are already saturated and have a growing share of the economy.
>Until CO-VID, until unemployment checks, until stimulus going out to people. Suddenly labor has an opportunity to negotiate. People are leaving their jobs and moving to higher paying ones.
Fiscal spending does the obvious. Keynes would say the government is increasing aggregate demand. Well, more importantly it's increasing the demand for labor faster than the supply of labor, giving workers the upper hand.
>So the rivers are rising. The Fed has to react according to their mandate. What will they do? The same thing they have done the last 8 times since the 70's, they rise rates.
Well, the fed was created to spread risk among banks via central bank reserves and to kill inflation. The Fed can't actually create inflation. QE doesn't create inflation. It's only the government that can increase inflation via fiscal policy and it should use it for long term investments. Things that are still there in 30 years.
> The Federal Reserve has two mandates: maintaining maximum employment and maintaining stable prices and moderate long-term interest rates.
This seems fine at first glance, until you see that maximum employment does not mean maximum employment, and in fact you can have more than maximum employment. Last decade we had more than maximum employment and the Fed was expecting inflation that did not come. "Struggling to reach 2%".
Why was the Fed expecting inflation? Because when you have more than full employment, it converts the labor market from a buyer's market to a seller's market. This ties in with the other side of it's mandate: stable prices. Why would prices rise? If you read my water analogy comment[0], you could see that there are only two real ways. The rivers are higher, or the reservoirs are leaking. We have not seen any signs of reservoirs leaking.
So then the rivers are higher. What is the CPI really tracking? What is the Fed trying to keep under control? The ability for labor to negotiate. Why did we not get inflation even though we had above maximum employment? Wealth inequality. Monopolies. The business owners have all but shut down a perfect competition in the economy and can without discussing openly, act like a cabal.
Until CO-VID, until unemployment checks, until stimulus going out to people. Suddenly labor has an opportunity to negotiate. People are leaving their jobs and moving to higher paying ones. Work from Home is having companies compete from all over the nation, now you are not limited by your building size, you can employ as much as you can handle. Wages are being negotiated. Suddenly it's a seller's market.
So the rivers are rising. The Fed has to react according to their mandate. What will they do? The same thing they have done the last 8 times since the 70's, they rise rates. It's a proven strategy that when the Fed funds rate rises above the 30 year treasury rate[1], it de-stabalizes the economy. As a result within short order we get a recession. Recessions mean job losses, which means the market moves back to a buyer's market. Labor is happy to have any job at all. The rivers fall. Inflation is back off the table. Once the goal has been reached and the market has switched, they go ahead and drop the interest rates back down to 0. Let the free money be free once again.
So long as it does not cause disruptions? Disruptions for whom? To me it looks like the system is working exactly as it was designed.
[0]: https://news.ycombinator.com/item?id=25646585
[1]: https://fred.stlouisfed.org/graph/?g=ENDs