Yield Curve Inversion

Anyone else notice the brief Yield Curve Inversion this week? The 10-year yield slipped below Fed Funds rate for first time since
the last recession.

Chris Isidore of CNN Money has the details:

"The inversion early Wednesday was different than the inversion that occurred late last year and early this year, when the 10-year Treasury yield fell below the yield on shorter-term Treasury securities.

Wednesday’s inversion came as the 10-year yield fell briefly below the fed funds rate, the Fed’s short-term rate target, currently 5 percent. It was the first time that’s happened since April 2001, the last time the country was in a recession.

The 10-year yield dipped briefly below the fed funds rate Wednesday morning after a report showed a big drop in demand in April for cars, refrigerators and other big-ticket items known as durable goods.

But when a report on new home sales came in above forecasts 90 minutes later, the 10-year Treasury yield edged back above the 5 percent level."

I continue to believe an economic slowdown is in the offing as stimulus fades, and the pig moves through the python. Recession odds for 2007 keep increasing. This despite what Ben "CPI overstates Inflation" Bernanke has said:   

"But in recent comments, Fed Chairman Ben Bernanke repeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is no longer a good indicator of a recession ahead.

"In previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint," Bernanke said in a speech in March. "This time, both short- and long-term interest rates — in nominal and real terms — are relatively low by historical standards."

Keep in mind that inversions are not binary — i.e., inversion or not. The depth and duration of an inversion are significant and contain information. The inversion this past Wednesday was "short-lived and relatively narrow. Some of the pre-recession inversions in the past were far more pronounced." Compare this with prior inversions:

"For example the gap between the 10-year yield and the fed funds rate were inverted for nearly 11 months and the gap reached 1.5 percentage points in January 2001, just before the Fed started cutting rates.

The recession that started in late 2000 lasted until the fall of 2001.

Still, an inverted yield curve is not something that can be ignored, the experts said.

"I think it would be healthy to be concerned, given the track record of the curve being a warning sign," said Schlesinger. "It’s important not to be trapped by past patterns. But it (the inverted yield curve) does raise a question about how far the Fed has to tighten."


Yields throw the Fed a curve
Chris Isidore
CNNMoney.com, May 24, 2006: 3:35 PM EDT

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What's been said:

Discussions found on the web:
  1. Zephyr commented on May 28

    The Fed never stops until after it has gone too far.

    There is a long lag between policy action and the impact from that policy action. We are still partially under the influence of the previous very low interest rates.

    The impact from the rate increases of the last 12 months have only begun to be felt. But the impact will come. The current rates are well above the average of the last 2 years. The recent “medicine” has not yet taken hold.

    Once again, the Fed has over medicated the patient.

    However, they have not overdone it by as much as they usually do. I believe that the neutral rate is under 4%. The rate increases prior to reaching 4% were just reduction of the stimulus. We are now modestly above neutral and should expect a modestly negative impact on the economy.

    Hopefully, they will stop and let their policy actions take hold.

    Otherwise by next year they will be prescribing the opposite treatment to counteract the over-dose of their 2006 policy.

  2. S commented on May 28

    So, to paraphrase Bernanke, “this time it’s different”.

    How many times have prognosticators of the financial markets wished they’d never uttered those words?

  3. Uncle Jack commented on May 28

    Yep, it’s different this time, until it’s not.

    I think Bernanke will be fighting those “helicopter” words from 2002 until the day he dies. He’ll have to come down on the market with a hammer before anyone will believe he’s a hawk. So Dovish Ben it is, regardless, or in spite of his present words.

  4. GRL commented on May 28

    This from Stratfor’s May 25, 2006 Global Market Brief:

    But while concerns for the future are not misplaced, and while growth is indeed likely cresting, there are still two more signposts that must pop up before an American recession is imminent.

    First comes the double dip. Generally, before a recession, markets have a sharp sell-off — such as the one that began May 17 — followed by a recovery and a second fall off. In general, the two dips are at least six weeks apart.

    Second, there would need to be an inversion in the yield curve. In its simplest sense, an inversion in the yield curve means getting money for short-term needs becomes harder than getting it for long-term needs. Often, such a circumstance means some investors sense an imminent recession and are attempting to lock in cash, thus driving short-term demand up. Other times, a belief the growth will last forever — think the dot-com bubble — drives demand for cash through the roof. The market always corrects such … misperceptions. Such corrections are known as recessions.

    The yield curve inverted extremely briefly in January, but has been broadly flat since. If the United States is indeed peering through the haze at a coming recession, the U.S. markets first need that other dip, and then the yield curve needs to arch its back. Generally, the lag time between a yield curve inversion and a recession’s start is about six months.

    As we noted in our annual forecast, 2006 will be a banner year, particularly for the United States.

    But 2007 is looking sketchier by the day.


  5. Cherry commented on May 28

    2006 will be not be a banner year. Nada my friend.

  6. dallas boomer commented on May 29

    An inverted (or flat) yield curve is merely a piece of information that needs to be investigated to determine what the underlying causes may be. IMHO the current yield curve is more due to foreign demand for long term US debt than tightness in credit markets. The Fed should be more worried about things it can control/influence such as M2 growth, which has only been growing at 4.9% of late, compared to 5.3% GDP expansion. This is hardly a monetary policy that accomodates inflation.

  7. Leisa commented on May 29

    “In its simplest sense, an inversion in the yield curve means getting money for short-term needs becomes harder than getting it for long-term needs.”

    There’s a bit of a fallacy in the above statement. It’s not that getting s-t money get’s harder, it merely gets more expensive. You can have expensive s-t money that is hard to get, and you can have expensive money that is easy to get. At least that has been my experience in a commercial setting through a couple of recessions. I would suspect that higher s-t dissuades the speculative bunch, but it doesn’t dissuade corporations who need it to finance working capital needs. Given the level of speculative money, it would seem that drying that up would be a help some of the commodity prices. What I’d love to see, is someone take commodity prices–you pick one–and parse out the speculative piece v the fundamental piece. I’d like to see some sensible person draw a graph that factors in the fundamentals (supply, demand), computes the slope of that over time while bumping it up against another line showing the speculative piece and the effect of that over time and computing the delta so that dummies like me can understand the magnitude of risk inherent in the pricing. Barry–that would be a nice bit of analytics to kick your service off! I agree with dallas b. that the demand for our debt HAD been keeping rates low. Emphasis on the past tense.

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