Continued uncertainty regarding the life cycle of the new coronavirus contagion is flattening the yield as a flight to quality is driving down treasury yields. With the Fed expected to stay on hold this week, shorter maturity bond yields have declined less than long term maturities.
So this week the Fed is facing an inverted yield curve inverting once again and yet some investors think the Fed may actually increase the rate being paid on excess reserves from 1.55% to 1.60% all because the actual fed funds rate has gone 0.01% below the rate being paid. Raising the rate would just make the repo problem worse by increasing the incentive for banks to hoard cash at the Fed and cement the Fed as the lender of first, not last, resort for daily liquidity. With the yield curve already inverted from T-Bills to the five year, we just don’t see a rate increase to the interest on excess reserves making sense. But given the Fed’s clumsy and failed attempts to extricate themselves from the repo market, another policy mistake is definitely possible. If anything, the Fed might step up its purchases of T-Bills to try and combat the inversion on the short end.
Lastly, the Fed will likely give a nod to the hit to global growth from the coronavirus outbreak which could resteepen the curve as investors could take it as opening the door to a possible rate cut in the future.