Why Harker says yield curve inversion would be different this time

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The economy looks fundamentally sound, leading Federal Reserve Bank of Philadelphia President Patrick Harker to question the importance of a yield curve inversion.

“While it has often been the case that inversions in the yield curve have preceded downturns, a couple of points bear mention, particularly because they offer some assurance, Harker told a chapter of the National Association for Business Economics in Philadelphia Thursday, according to prepared remarks released by the Fed.

First, he said, “correlation does not equal causation, and while there appears to be a relationship between yield curve inversions and recessions, it’s not a foolproof indicator. Second, the playing field is different this time around. The Fed’s balance sheet is still historically large … which may be influencing long-term yields.”

Harker said he uses many indicators to shape his views, and many “point to a fundamentally sound U.S. economy.”

As a result, he continues to expect the Fed to raise rates at most once this year and once again in 2020.

Discussing the Fed’s balance sheet, Harker said, “while the balance sheet is clearly part of the discussion of monetary policy, it is not currently indicative of our monetary policy stance.” The Fed announced it will stop runoff in September. “This will not quite be the end of normalization” since reserves “will likely still be somewhat above the level needed to efficiently and effectively implement monetary policy, and our ultimate goal for reserves is ‘no more than necessary.’”

While average reserves will decline “very” gradually after that, he said, the Fed with working with “estimates of the demand for reserves, which means we should approach the ‘efficient and effective’ level with caution.”

Moving slowly and steadily, “is not only the safer option, it has the additional advantage of reducing uncertainty about the evolution of asset redemptions, and proceeds in the FOMC’s preferred ‘gradual and predictable manner.’”

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Monetary policy Patrick Harker Federal Reserve FOMC
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