"US Interest Rates Must Rise to at Least 5%"... Largest Inversion Between Short- and Long-Term Rates in 40 Years

[Asia Economy Reporter Byunghee Park, New York=Special Correspondent Seulgina Jo] James Bullard, President of the Federal Reserve Bank of St. Louis and a prominent hawk in the U.S. Federal Reserve (Fed), argued that the U.S. benchmark interest rate needs to rise to at least 5%. Amid a series of hawkish remarks from Fed officials, the inversion between long- and short-term U.S. Treasury yields has widened to its largest level in 40 years, raising concerns about an economic recession. Expectations for U.S. tightening have eased, and the dollar has started to strengthen again.

Fed Officials Make Consecutive Hawkish Remarks

According to Bloomberg on the 17th (local time), President Bullard said at an event held in Louisville, Kentucky, "In the past, I said 4.75 to 5%, but based on current analysis, I now say 5 to 5.25%," adding, "5 to 5.25% is the minimum range we need to reach."

Bloomberg reported that the market's expected peak for the benchmark interest rate was 4.6% last September, and Bullard's remarks dealt a blow to the market. The current U.S. benchmark interest rate is 3.75 to 4%.

Bullard even emphasized that in the worst case, the benchmark interest rate should be raised to 7%. He argued, "So far, the Fed's tightening has been insufficient, and its effect on curbing inflation has been limited."

Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, also said at the 2022 Economic Summit hosted by the Minnesota Chamber of Commerce on the same day, "We do not yet know how much more the Fed needs to raise rates until demand finds balance," adding, "Rate hikes should continue at least until it is confirmed that inflationary pressures have stopped."

Mary Daly, President of the Federal Reserve Bank of San Francisco, also responded to a question about the appropriate level for the benchmark interest rate the previous day, saying she thinks around 4.75 to 5.25% is appropriate.

Goldman Sachs: U.S. Rate Peak at 5 to 5.25%

With consecutive hawkish remarks from Fed officials, the inversion between long- and short-term yields has deepened. Foreign media reported that the recent inversion between the 10-year and 2-year U.S. Treasury yields is at its largest level in 40 years. According to MarketWatch, the inversion between the 10-year and 2-year U.S. Treasury yields reached 0.705 percentage points on February 18, 1982. On that day, the 10-year Treasury yield closed at 4.365%, and the 2-year Treasury yield at 3.694%, resulting in a yield difference of 0.671 percentage points. According to the Fed website, the yield difference between the 10-year and 2-year bonds was 0.66 percentage points that day, and the previous day it was 0.68 percentage points, indicating a larger inversion.

The inversion between long- and short-term yields is interpreted as a precursor to a recession. Typically, long-term yields are higher, but when concerns grow that rate hikes will hurt the economy, short-term yields, which are more sensitive to monetary policy, rise faster than long-term yields, narrowing the gap. If recession fears intensify, an inversion like the current one occurs. The inversion between the 10-year and 2-year yields has persisted since early July.

Goldman Sachs raised its forecast for the peak U.S. benchmark interest rate from 4.5-4.75% to 5-5.25% in a report released the previous day, estimating a 35% chance of a U.S. economic recession within the next 12 months.

The Dollar Rises Again

The series of hawkish remarks from Fed officials threw financial markets into turmoil. The New York stock market, which had been on a strong upward trend since last week, fell for two consecutive trading days. The expectation of a slowdown in rate hikes diminished, weakening risk asset appetite. The Nasdaq index, which is tech-stock heavy and sensitive to interest rates, closed at 11,144.96, down 0.35% from the previous session. The S&P 500 index, dominated by large-cap stocks, also fell 0.31%.

Mark Haefele, Chief Investment Officer (CIO) of UBS Global Wealth Management, said, "Additional tightening and the cumulative impact of rate hikes this year suggest that recession risks remain high," adding, "The macroeconomic prerequisites for a sustained rally, namely rate cuts and a bottom in growth and corporate earnings, have not yet arrived," forecasting a bearish market ahead. The head of global economic research at Bank of America (BoA) stated, "Unless core inflation falls sharply, the Fed is very likely to push the economy into a deeper recession than expected."

The dollar, a representative safe-haven asset, showed strength. The Dollar Index, which measures the value of the dollar against six major currencies, rose 0.34% to 106.65. In the New York foreign exchange market, the yen and euro fell 0.49% and 0.27%, respectively, against the dollar.

On the other hand, oil prices fell due to recession concerns stemming from tightening. At the New York Mercantile Exchange, December West Texas Intermediate (WTI) crude oil prices closed at $81.64 per barrel, down $3.95 (4.62%) from the previous session. This closing price was the lowest since September 30. The sharp rise in new COVID-19 cases in China also increased the possibility of lockdowns, exerting downward pressure on oil prices.

This content was produced with the assistance of AI translation services.