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Fed's Kashkari warns against ignoring inverted yield curve

The Federal Reserve should not ignore recent inversions in the yield curve given that the bond market signal is the "single best predictor" of a U.S. recession, Minneapolis Fed President Neel Kashkari said Sept. 4.

Bond markets may have "figured something out that the rest of us haven't," and policymakers should not brush off their worries about a potential recession, Kashkari said at a town hall in Minneapolis.

Inversions in the yield curve when long-term Treasury yields dip below those of shorter-term notes and bills have historically been followed by U.S. economic downturn within a year or two.

While some have said the yield curve's predictive power is less accurate today, Kashkari cautioned against believing the adage "This time is different," which he considers the "most dangerous words in economics."

"I don't believe 'This time is different,'" Kashkari said. "I'm certainly not willing to bet the U.S. economy on 'This time is different,' so this is probably the most concerning signal that we're seeing right now."

The spread between the yields on 10-year Treasury notes and 3-month bills has been negative for several weeks this year, and the difference between the yields on 10-year Treasurys and 2-year Treasurys has dipped into negative territory a few times in recent weeks.

Those trends signal that bond investors are nervous about the prospects for U.S. and global growth and that they "don't see evidence that inflation is about to take off," Kashkari said.

Kashkari and other Fed officials have listed below-target inflation as one reason to cut interest rates, along with concerns about slower global growth and persistent uncertainty on trade policy. The Federal Open Market Committee, which lowered rates by 25 basis points July 31, is widely expected to ease policy again at its next meeting on Sept. 17 and 18.

Fed Chairman Jerome Powell did not push back against expectations of another 25-basis-point cut during his Aug. 23 speech in Jackson Hole, Wyo. Analysts will be closely watching his upcoming Sept. 6 appearance for any signs of a shift in messaging.

Fed officials appear to be somewhat split as they head into their next meeting. Boston Fed President Eric Rosengren, for example, indicated Sept. 3 that he thought it was too early for the Fed to be cutting rates, while St. Louis Fed President James Bullard called for a 50-basis-point cut in an interview with Reuters. Both are voters on the FOMC this year.

The Minneapolis Fed president does not have a vote this year at FOMC meetings, but he participates in its discussions. He had called for a 50-basis-point rate cut at the July meeting, a more aggressive action than most of his colleagues favored.

Kashkari did not explicitly share his view of what action he would favor at the September meeting, but he said the Fed's benchmark interest rate is "moderately contractionary."

Tapping the brakes on the U.S. economy is unnecessary when inflation is muted, Kashkari said. The U.S. is also seeing greater downside risks to its outlook as trade policy uncertainty continues dampening business investment, which is leading to slower growth abroad that will spill over into the U.S. economy even if its underlying fundamentals are solid, Kashkari said.

"If the rest of the global economy slows down, that will end up slowing down the U.S. economy too," he said.