Long-term Treasury yields remain low despite the fiscal stimulus from the Trump tax cut because of a mistaken belief on Wall Street in the theory of the “new normal”, said Kevin Hassett, White House’s top economist.
“The previous administration’s economists…had convinced everybody that we’re in this new normal,” that had nothing to do with President Barack Obama’s economic policies and was “exogenous,” Hassett said on Wednesday during a moderated discussion at the Summit on the Economy sponsored by the Economic Innovation Group and the Governor’s Woods Foundation.
Hassett forecast that second-quarter growth of gross-domestic-product is likely to boost the 12-month growth rate above 3%.
“Enough of the market was convinced by the new normal guys that we’re stuck slowly [growing] forever, that one good year of 3% hasn’t really changed their minds about growth five years from now,” Hassett said.
“The question is – is it a blip?” he asked, and then went on to say that it wouldn’t be.
“What is going to happen is we’re going to have 3% growth this year, we’re going to have 3% growth next year and we’re going to ask ourselves next year about the year after that,” he said.
“And as that happens, one could expect an effect on the yield curve,” he added.
The yield on the 10-year Treasury note
briefly rose above 3% in mid-May, a seven-year high, but has since fallen back below 2.9% since mid-June. Bond yields rise as prices fall.
The yield gap, or yield curve, between 2-year Treasurys and the 10-year note, sensitive to inflation expectations and market fears, are at the narrowest since August of 2007. The 2-year note is the most sensitive to the Federal Reserve’s efforts to normalize interest rates from post-crisis levels.
The uncanny spread tightening between 2-year and 10-year paper, is particularly notable because investors tend to demand a richer yield for lending over a longer period, with lower rates at the longer end suggesting that investors are communicating concerns about the long-term economic outlook or stagnant inflation.
Moreover, an inverted yield curve, where short-dated notes yield more than their longer-term counterparts have been an accurate predictor of recessions.
Private forecasters don’t share Hassett’s optimistic growth projections.
The Philadelphia Fed’s survey of 36 economic forecasters sees predict real GDP growth of 2.8% in 2018, 2.7% in 2019 and 1.9% in 2020.
The term “new normal” in these circumstances was coined by Mohamed El-Erian, the chief economic adviser at Allianz, and was popularized by former Treasury Secretary Larry Summers, who termed it “secular stagnation.”
The basic idea is that slowing population growth would mean low investment demand contributing to slowing rate of economic expansion.