Yield Curve Flattening a Symptom of Ineffective Policy Tightening

Executive summary: • A flattening yield curve highlights Federal Reserve rate hikes’ inability to tighten financial conditions, as low long-term interest rates continued to induce institutional investors to “reach for yield” by moving up the risk ladder • Central banks initiating “short volatility positions” via QE have dampened long-term sovereign bond yields, which crowded out private capital and induced investors to “find something else to do” by buying more esoteric assets • A flat yield curve alone would only pave the way, rather than directly trigger events that result in recession, as persistently low long-term bond yields increase the probability and magnify the impacts of balance sheet crises • Prolonged easy financial conditions as a result of ineffective tightening is not costless, for uneven wage growth and rapid asset price appreciation have exacerbated inequality to heighten financial, social and political instability