Will Fed rate hikes trigger a recession in 2018?

By Jeff Lazerson

When it comes to inflation, Federal Reserve Chairwoman Janet Yellen reminds me of Chicken Little.

Disregarding clear evidence that the U.S. economy lacks any real inflation threat, last week Yellen and company raised short-term interest rates. This is the fourth rate raise — all of which started in December 2015.

So, what’s the harm in raising rates? After all, Yellen is certainly to be admired for her love of country and her determination in stopping inflation from ruining our great American economic expansion of eight years and running.

Markets are reacting as truth sayers. Consider the flattening yield curve. A flattening yield curve is when there is less than 100 basis points difference between short-term interest rates and long-term interest rates.

Short-term rates are directly and indirectly controlled by the Fed’s rate moves. And, long-term rates (which influence mortgage rates) are market driven — not controlled by the Federal Reserve.

The two-year U.S. Treasury note (short-term) continues to steepen, currently at 1.36 percent. The 10-year U.S. Treasury note (long-term) continues to drop, now down to 2.16 percent. There is just an 80-basis point difference in respect to these closely compared borrowing instruments.

The next worry is an inverted yield curve. That is where the short-term rates are actually higher than long-term rates.

The result of an inverted yield curve is banks pull back from any short-term lending. It makes no economic sense to lend under these circumstances. Boom! Recession is likely to follow because bankers shut down the credit window.

Fun facts: Since 1975, the U.S. experienced six flattening yield curves. Five out of those six resulted in an inverted yield curve, according to Michael Pento, president and founder of Pento Portfolio Strategies.

Since World War II, the Fed has raised rates 15 times (defined as three or more short-term rate increases within 12 months), 10 of which have resulted in recessions, Pento added.

You read that correctly. Most flattening yield curves end up in inversion mode. Once inverted, you run a two-out-of-three chance of a recession. Holy statistical acorns!

The Mortgage Bankers Association doesn’t agree.

“We don’t think the yield curve will invert,” said Lynn Fisher, MBA’s vice president of research and economics. Citing the currently strong labor market and low inflation, Fisher thinks some previous recessions happened because the Fed waited too long to raise rates in response to high inflation.

I see an inverted yield curve occurring by the end of 2017. I see a recession following shortly, thereafter. I see lower mortgage rates ahead.

You may say that I’m Chicken Little for crying, “Recession.” I say Yellen is Chicken Little for crying, “Inflation.”

If the sky falls, it may be Yellen’s fault.

If you have questions or comments, please contact Jeff Lazerson by clicking here.