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1. We discussed the term structure and yield curve this week. Yields on longer-term U.S. Treasurys have fallen further below those on short-term bonds than at any time in decades, a sign that investors think the Federal Reserve is close to winning its inflation battle regardless of the cost to economic activity. However, a study also shows that if the yield curve is inverted continuously for at least two months, there is an 83% chance of a recession soon. (please refer to the article: “Wall Street’s Favorite Recession Indicator Is in a Slump of Its Own”: https://www.wsj.com/finance/investing/wall-streets-favorite-recession-indicator-is-in-a-slump-of-its-own-ee885cb9?st＝wbpho9ztbuj8otz&reflink＝desktopwebshare_permalinkLinks to an external site. and the WSJ video″ Why Inflation Has Lasted for So Long″ https://www.wsj.com/video/series/news-explainers/why-inflation-has-lasted-for-so-long/5CAFFC5A-BBDC-4B6C-A34E-57491576E9B9Links to an external site.)
What does an inverted yield curve indicate about the market′s future expectations for short-term interest rates, and why? Why do you believe that the yield curve has been inverted for so long without us experiencing a recession? In your opinion, will the economy be in trouble in the next 6-12 months? Please discuss.
2. There will always be a close relationship between government bonds and currency. Foreign investors will first have to exchange their local currency for the dollar to purchase our government bonds. As the Federal Reserve increased interest rates, the attractiveness of our government bonds and the demand and price of the dollar have also increased. While a strong dollar has its many advantages, it can decrease exports as our goods and services become more expensive for foreign consumers. With our deficit spending and increase in the monetary base, more dollars in the secondary market should lead to a dollar price weakness. However, “higher for longer rates” or even increasing rates could lead to further dollar strength. (Please refer to the WSJ article” The Dollar Is at Its Strongest Since the 1980s. Can It Last? https://www.wsj.com/economy/the-dollar-is-at-its-strongest-since-the-1980s-canit-last-a1d407b9?st＝t7h1nvu8paaf9mi&reflink＝desktopwebshare_permalinkLinks to an external site.
Please discuss how an overly strong/weak dollar affects the stock market. What are the factors that could lead to further dollar strength or weakness? Explain how a weaker dollar can help narrow the U.S. trade deficit.
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