Rhody Trader

There’s a considerable amount of talk among economists and market participants of late about the inflationary implications of all this stimulus and whatnot that’s being put out there. Some people are looking at the steepening yield curve as evidence that this is being worked into market expectations. The chart below shows how the spread between 2year and 30year Treasury yields has moved over the last 6+ months.

I’ll accept that inflationary pressures are probably a part of the recent upswing in the slope of the yield curve. I think that’s not really the big issue at the moment, though.

Stay with me here.

Inflation is a monetary thing – too much money chasing too few goods. If the argument is that production of goods will decline, and that will lead to inflation, then fine. But I haven’t heard that argument to this point. It’s always the other side – expanding money supply.

But are we going to get massively expanding money supply? You might think yes because of all the federal spending for stimulus and bailouts and such, and because of the massive expansion of the Fed’s balance sheet. Here’s the thing, though. If the Treasury borrows to fund all that spending then that will actually drain all that spending back out of the system. The net effect would be zero. Money supply won’t stay elevated. As for the Fed, most of the lending they are doing is very short-term. They can shrink their balance sheet very, very quickly.

I think the bigger consideration in the rise in longer term Treasury rates is much more to do with the expectation of increase supply.

This, of course, is something I’ve had in mind for quite some time now, as you can see from my Playing for a rise in interest rates post I wrote back in October.

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