Cathie Wood Warns Fed Has Made 'Serious Mistake' As Yield Curve Inversion Steepens

Topline

High-profile stock picker Cathie Wood, the chief of asset manager Ark Invest, on Wednesday laid into the Federal Reserve’s aggressive plan to fight inflation, joining some experts in arguing the consequences of the central bank’s interest rate hikes could ultimately outweigh the benefits—but others warn of exactly the opposite risk.

Many economists believe the risk of doing too little to fight inflation could be worse than doing … [+] too much—and most don’t believe a potential recession would be anything worse than mild.

Photograph by David Yellen/The Forbes Collection

Key Facts

In a series of Wednesday morning tweets, Wood, who has been critical of the Fed’s interest rate hikes before, said the bond market “seems to be signaling that the Fed is making a serious mistake,” as yields on 10-year Treasurys fall 80 basis points below those on 2-year Treasurys—marking the steepest yield curve inversion since the 1980s.

Yield curve inversions have long been viewed as a telltale sign of a looming recession, suggesting investors are more bearish about the future than the near term, and on Wednesday Wood argued the current inversion “is much more of a red flag for the Fed today than it was in the early ’80s,” when the economy faced double-digit inflation (versus 7.7% in October).

“Deflation is a much bigger risk than inflation,” Wood said, arguing that healing supply chains and tumbling oil prices suggest the Fed has done enough to tame rising prices and pointing to the negative inflation that led to the Great Depression as evidence of the potential risk.

According to Fed economists, as inflation dips early in a recession, people can begin to expect inflation will fall more—expectations that can intensify as a recession grows deeper and longer, leading to lower prices and ultimately worsening the economic crisis, as occurred during the Great Depression.

Contra

Some economists have argued the Fed could be risking an unnecessary recession, but many also aren’t so sure inflation has slowed enough. Bank of America’s Michael Gapen says any delayed supply chain improvements could make inflation linger longer than the Fed expects and that current policy would likely only spur a “mild” recession. Further, Goldman economists in a recent note said they believe the Fed will likely act more aggressively than expected as inflation pressures persist, but that the economy is more likely than not to avoid a recession thanks to consumer spending that should remain strong.

Surprising Fact

The yield curve has been inverted—when long-term yields fall below longer-term returns—since June, but the inversion has steepened in recent months amid prolonged inflation and growing recession fears. A Fed study in 2018 found every recession in the past 60 years has been preceded by a yield curve inversion.

Key Background

The Fed’s interest rate hikes—and central bank tightening around the world—have triggered steep downturns in the housing and stock markets, and a growing number of experts worry the turmoil could ultimately spark a deep global recession. Nevertheless, policymakers have largely remained steadfast in their commitment to fight inflation, which remains nearly four times the Fed’s historic 2% target. In their latest announcement, central bank officials hinted they may slow the pace of hikes this month, but Fed Chair Jerome Powell, in the press conference that followed, said economic data suggests the Fed may ultimately move rates to higher levels than it projected in September and that the risk is doing too little rate-hiking, not too much.

What To Watch For

The Fed’s next interest rate announcement is slated for next Wednesday. Goldman economists forecast the central bank will authorize a half-point hike, followed by three quarter-point hikes next year. That would push the top borrowing rate to 5.25%—the highest level since 2007. Incoming inflation data on Tuesday, however, could lower—or raise—these forecasts.

Cathie Wood Warns Fed Has Made ‘Serious Mistake’ As Yield Curve Inversion Steepens—Here’s Why Some Experts Disagree