(Bloomberg) -- The risk that the Federal Reserve could soon hit the pause button on interest-rate hikes means the great flattening of the yield curve is almost over.
That’s the view of John Herrmann, a strategist at MUFG Securities Americas Inc. who has been accurately predicting for more than a year the compression between shorter- and longer-term rates. Herrmann has now abandoned his call from just a few months ago that the curve was on track to invert and believes that economic headwinds will prompt the Federal Open Market Committee to rethink how much it tightens policy.
The most recent projections from Fed officials themselves signal a hike in December followed by three quarter-point increases for 2019, although recent comments from policy makers suggest the consensus may be shifting. The market continues to see an increase as the most likely outcome for December, but with global stock prices sliding and concern about economic growth mounting, it has dialed back the amount of tightening priced in for 2019 to just 32 basis points from more than 50 earlier this month.
It’s “time to start thinking outside the box” about 2019 and 2020, Herrmann wrote in a note Tuesday. There has been “collateral damage” from the amount of rate increases since Jerome Powell took charge at the Fed, and along with signs of dimming U.S. growth that suggests the FOMC has to slow down the speed at which it hikes, according to Herrmann.
MUFG’s base case is for an increase in December, followed by just one hike in 2019 and another in 2020, and Herrmann warns that an even more dovish path is possible. MUFG’s models indicate there is a risk that the Fed won’t hike at all in 2019 as the global economy seeks to “digest” the increase in short-end rates that has already occurred.
This Fed backdrop means the yield curve lost its chance to invert, according to a separate email from Herrmann in response to questions. If the Fed were to pause for all of 2019, 2-year yields could decline another 16 basis points and 10-year yields might fall another 14 basis points, meaning the yield curve would not be biased to invert in 2019, he wrote.
