Feds & recession prospects

The goal has been to slow bubbly markets without raising rates. If the
US is raising rates while other countries are trying
to keep rates low, foreign inflows in US bonds
could rise. Indeed foreign inflows are one reason
why longer maturity rates did not rise in 2017.

If the US yield curve fattens because of a
combination of a rising policy rate and foreign
demand for bonds, it may not imply that a
recession is nigh – although markets and
companies might start acting as though one were
imminent with unpredictable consequences.

In any case the US economy would still be
vulnerable to a withdrawal of those funds.
Also, investors should pay close attention to
the Fed’s QE unwind program. A simple way to
look at the unwind is simply as a repeat of the last
seven years but in reverse. Since the huge
monetary infux did not translate into much
lending activity or price pressures – tellingly, M2
velocity dropped one-quarter to 1.5 times – a
reversal should not pressure banks to curtail or
call in outstanding loans. Likewise, tighter money
may not have much impact on inflation or
economic activity.

Rather, as the money supply
growth slows volatility will rise.