I know none of this is terribly new or groundbreaking, and I’ve oversimplified for the sake of parsimony, but here’s the null hypothesis:
The US yield curve reflects a global equilibrium rate for ‘risk free’ financial assets much more than it does any kind of capital formation equilibrium rate. In other words, it equilibrates financial activity, and economic activity is somewhat of a price taker.
Not only is the yield curve much more driven by financial balances these days, but, within financial balances, the share of price-insensitive demand for risk-free assets has grown sharply. And at the same time the supply for these assets has contracted.
Here are a few reasons why:
- Rating agencies were chastened by the GFC and aren’t slap happy with AAAs anymore
- Derivative structurers are, let’s say, more modest in their issuance ambitions
- Insurance companies and pension funds have endless structural demand
- Banks have higher liquidity requirements to meet
- Central bank QEs
This isn’t to say yields don’t react to economic info or don’t say anything about the state of the economy. Of course they do. But the dominance of financial drivers after 30 years of global financial deepening has made attempts to extract economic information from the level and shape of the US yield curve unhelpful–or worse, vulnerable to false positives.