For about a week the bond market was in a tizzy about the inversion in the 2-10 Treasury curve where the two year note yielded a bit more than the 10-year note. Market particpants were screaming "Rececession, Recession." Then, of a sudden a few Fed speakers came out like screaming hawks and from an inversion of about 9 basis points the yield curve normalized at a higher level with the 10-year yielding about 20 basis points more than the two year.
What was brought home to market particpants is that the Fed has the ability to control the yield curve. At the height of quantitative easing there was much discussion about yield curve control where the Fed would fix the 10 year yield at an unusually low level, a throwback to its 1940's policy. Now, however, with a $9 trillion balance sheet the Fed with quantitative tightening can all but fix the 10 year yield wherever it wants it. Thus it has the ability to keep the yield on the 10-year note above the 2-year note thereby preventing an inversion.
My sense is that recession fears for 2023 are overdone, but 2024 could be another story. To be sure the very significant backup in interest rates will slow the economy. Nevertheless, if inflation declines to the 4-5% range by yearend a 2-3% Fed Funds rate would still be signalling negative real yields. Thus monetary policy remains far from contractionary and it will likely take a positive real Fed Funds rate to break the economy.
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