Random Walk

PERHAPS it’s just a coincidence, but Treasury-bond yields peaked at 8.16 per cent on November 7, the day before the Republicans swept Congress. Since then, long-term interest rates have fallen to just above 7.5 per cent, even while Fed Chairman Alan Greenspan has raised the federal-funds rate to 6 per cent from a pre-election level of 4.75 per cent. As a result, the spread between bond yields and money-market rates has narrowed from 340 to 155 basis points.

A flatter yield curve usually signals lower inflation expectations, and that is consistent with the pattern of slower growth in high-powered money created by the Fed. Annualized growth in the key measure known as Federal Reserve credit—the central bank’s balance sheet of commercial bank loans and Treasury security investments— dropped from 14 per cent in late 1993 to only 5.5 per cent during the past six months. This is not as tight as in 1989—90, when Fed credit dropped to 3 per cent growth prior to 1990’s recessionary tax increases, but it is substantially tighter than the easy money Greenspan provided in 1992-93.

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PERHAPS it’s just a coincidence, but Treasury-bond yields peaked at 8.16 per cent on November 7, the day before the Republicans swept Congress. Since then, long-term interest rates have fallen to just above 7.5 per cent, even while Fed Chairman Alan Greenspan has raised the federal-funds rate to 6 per cent from a pre-election level of 4.75 per cent. As a result, the spread between bond yields and money-market rates has narrowed from 340 to 155 basis points.

A flatter yield curve usually signals lower inflation expectations, and that is consistent with the pattern of slower growth in high-powered money created by the Fed. Annualized growth in the key measure known as Federal Reserve credit—the central bank’s balance sheet of commercial bank loans and Treasury security investments— dropped from 14 per cent in late 1993 to only 5.5 per cent during the past six months. This is not as tight as in 1989—90, when Fed credit dropped to 3 per cent growth prior to 1990’s recessionary tax increases, but it is substantially tighter than the easy money Greenspan provided in 1992-93.