On June 14th, the Federal Reserve raised rates for the third consecutive quarter. While well-telegraphed, to say the least, we are now left to decipher the possible implications of this move. We believe the focus should not be on the number of rate increases or the absolute level of rates, but rather the shape of the Treasury yield curve.
The Treasury yield curve made new 2017 lows on June 14. This means the spread between the 2-year Treasury and the 10-year Treasury is only .81%. As a point of reference, last month the spread was 1.04%, compared to 2014 when the spread was over 2.5%. 
In our view, recent economic data points don’t tell a clear story. For example, inflation is moderate in the face of strong employment gains. In her press conference after the Fed meeting on June 14, Chairwoman Yellen remarked on some of these conflicting data points, while foreshadowing that a further rate increase could happen this year. We believe that further rate increases could be dangerous given the level of longer-dated Treasuries, and that further flattening of the yield curve will be damaging to the banks. We remain underweighted in financials for this reason.
We believe that three things need to happen for the U.S. economy to tip into recession:
- the Treasury yield curve goes negative (inverted)
- the spread between Treasuries and corporate bonds widens significantly, and
- real money growth goes negative
So far, we believe that we are clear on all fronts, but from an investment perspective, caution is warranted.
In light of the Fed’s recent decisions, we stand ready to speak with you to discuss current market conditions and how Anchor’s focus on uncovering long-term value can help you navigate the financial waters with caution.