Gluskin-Sheff economist David Rosenberg isn’t known for mincing his words, and today he spent a fair amount of time looking at Fed policy options in the near-term. His conclusion? The Fed is out of bullets on the funds rate, and all it really has left is the ability to influence the long end of the yield curve:
We know that Ben Bernanke, even with his sky-high IQ, is not the world’s best economic forecaster. And, we know that he is reactive, not proactive. But based on what he did in late 2008 and early 2009, we also know how aggressive he is willing to be, and he also knows deep inside that we are dealing with a modern-day depression. Buying more Treasuries at some point, perhaps not that far off in the distance, is still in the policy arsenal and as such, today’s near-4% yield in the long bond is going to look a whole lot like the 5% yield back in the summer of 2007, the 6% yield in the spring of 2000 and the 7% yield back in the fall of 1996 — a bargain. You can see this across the yield curve as the 2-year note converges on Fed funds; the 5-year note on the 2-year note; the 10-year note on the 5-year note; and the long bond on the 10-year. Every segment of the curve will be flatter when this thing is over, and when it is over, yields across the curve will be at stupid-low levels. What sort of levels? Well, consider that in the past decade, the average spread between the 10-year note yield and Fed funds is 160 basis points; between the long bond and Fed funds is 210 basis points; and between the long bond and 10-year note, the spread has averaged 50bps (it is 125bps today!).