Yield Curve: Its different this time

I love the serendipity when two separate analyses show up saying the opposite thing.

Such was the case this weekend, when I was looking at Art Laffer’s recent commentary on the Yield Curve.

Then this morning, a WSJ front page (C1 of the Money & Investing section) had an article on the same subject.

Let’s have a look at each, and see if there is anything to be derived fromt his tension:

Art Laffer created the Laffer Curve, and is known as the father of Supply Side Economics. He’s a genial guy whom I’ve debated a few times on Larry Kudlow’s show.

Our prime economic disagreement (aside from my agreeing with Greg Mankiw on Supply Side econ) is that Laffer credits tax cuts for the expansion of this cycle. I, on the other hand, look at the 2001 and 2003 tax cuts as having some marginal impact, but not neccessarily long lasting. I credit the ultra-low interest rates for the upswing in housing, hiring, and consumer spending, and its positive impact on the rest of the economy from 2002-2006. That impact has begun to unwound and is now turning negative. 

Laffer believes the S&P 500 is undervalued by 67.2%, while I believe we are overdue for a correction of some significance. I guess we both believe the market is less efficient than many economists and academics assume.

I have said that an inverted yield curve is a warning sign; The longer and deeper the yield curve is inverted, the more meaningful a slowdown we are likely to get. Note that this is a probability analysis. Based on the yield curve alone, a recession is a 40-50% possibility. Other factors move that up to 60%.

Laffer disagrees:

"In the past cases of the yield curve’s successful “predictions” of future recession, the stock market was either flat or dropped sharply. During the present yield curve inversion, the real S&P 500 index has increased some 11.3%.  The stock market is most definitely not forecasting a recession.

• Past inversions were due to a credit crunch that drove up short term yields. We see no evidence of a credit crunch in today’s market.

• In the late 19th and early 20th centuries, inverted yield curves were typical. The upward-sloping yield curve has only been “normal” in the post-World War II era, when long-run inflation became the norm.

• TIPS yields point to continued prosperity.

There certainly is no credit crunch these days; As to the 19th century versus post WWII eras, I suspect the past 60 years is more relevant than the 1800s, which predates most of the world’s central banks now in existence.

And you’ve heard me say this many times prior: Beware Economists relying on the stock market as proof of the economy.   

Let’s go back to the issue of inverted yield curves: Several other Bond market watchers have noted the issue. From this morning’s WSJ:

"Yield inversions, many analysts say, are harbingers of hard times. When bond investors see a recession coming, they tend to buy long-term Treasury securities for two reasons. First, they are safer than stocks. Second, they are appealing when inflation is low, and recessions tend to beat down inflation. The buying that comes with recession fears drives down a long-term bond’s yield, sometimes below the prevailing yield on short-term Treasury securities . . .

One economic-forecasting tool using Treasury yield-curve data pegs the chances of a recession at nearly one in two. The model, which was developed by Fed economist Jonathan Wright, takes into account yields on 10-year and three-month Treasury securities as well as the Fed’s overnight funds rate.

Another forecasting model — developed by Federal Reserve Bank of New York economists using only the 10-year/three-month spread — puts the chances of a recession in 12 months at just under 40%."

What do the dismal scientists on the Street of Dreams think? The WSJ notes that "Those predictions are at odds with the consensus among economic forecasters. A recent survey of economists by The Wall Street Journal pegged the chances of a recession within the next 12 months at 27%."



Graphic courtesy of Laffer Associates   

So is the Yield Curve still relevant? There is a dispute amongst economists to that effect. In addition to the aforementioned Mr. Laffer, several other notables have raised questions:

"Two researchers who focus on recession forecasting, Lakshman Achuthan and Anirvan Banerji of the Economic Cycle Research Institute, argue that the yield curve is overrated as a recession harbinger. They note that the yield curve failed to invert before recessions in the 1950s and early 1960s. They also point to the misleading signal sent in 1966-67, when a lengthy inversion didn’t precede a recession."

We know that there were recessions that were not preceded by an inverted yield curve. But were there inverted yield curves that didn’t produce a recession?

"Those who think highly of the yield curve’s predictive power have history on their side. Seven times between 1965 and 2005, yields on the 10-year note have dropped below those on the three-month Treasury bill for an extended span. In six of those instances, the U.S. economy went into recession soon after.

For example, the 2001 recession was predated by a yield-curve inversion that lasted from July 2000 to January 2001. In the one time when a recession didn’t follow, in the mid-1960s, there was still a sharp slowdown in growth."

That is a rather significant track record that suggests inverted yield curves ought to be closely watched for other confirming signs. And I am watching the following very closely: Transports, Retail sales, Durable Goods, Manufacturing, Housing Foreclosures, Auto sales, Business Capex. These are significant sectors of the US economy — and all of these indicators are flashing a danger sign.

One other warning factor worth watching:  Laffer ends his piece by claiming "This time is different!" History teaches us that those are the four most expensive words in the English language.


Grading Bonds on Inverted Curve
If Investors Are Betting On Lower Rates, Does a Recession Loom?
January 8, 2007; Page C1

Arthur B. Laffer
January 3, 2007
(No website)

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What's been said:

Discussions found on the web:
  1. Steve commented on Jan 8

    Based on the yield curve alone, a recession is a 40-50% possibility. Other factors move that up to 60%.

    What are these other factors?

    BR: Read the last 2 paragraphs of the post

  2. winjr commented on Jan 8

    Note that in most instances, a recession does not occur while the yield curve is steepening — it occurs as the yield curves begin to normalize.

  3. Macro Man commented on Jan 8

    So why has yield curve inversion failed to forecast recession in the UK, Australia, and New Zealand over the last several years? A cursory glance at the growth of central bank foreign exchange reserves over the past several years suggests that something significant has in fact changed.

  4. Steve commented on Jan 8

    I guess my question is why do you go from 40-50% based on the yield curve and then up to 60% based on other indicators?

    Why would these be additive? Wouldn’t the inverted yield curve 40-50% prediction already reflect these other data?

  5. Charles Butler commented on Jan 8

    –“Seven times between 1965 and 2005, yields on the 10-year note have dropped below those on the three-month Treasury bill for an extended span. In six of those instances, the U.S. economy went into recession soon after.”

    Not that I necessarily disagree with your conclusion, but.. The sample’s a little stingy. No? Could it not be that long rates are reflecting a consensus on future geopolitical risk which is, INHM, way lower than it has ever been in any currently living person’s lifetime? Put otherwise, would – given identical economic conditions – the curve be inverted in the year 1962? I somehow doubt it.

  6. winjr commented on Jan 8

    “A cursory glance at the growth of central bank foreign exchange reserves over the past several years suggests that something significant has in fact changed.”

    What would that be?

  7. Philippe commented on Jan 8

    Mr Laffer seems to quest both opinion, equities and yield curve in order to confirm the yield curve reading (difficult tautology).
    The yield curve has always pretended to have the power of reading economic cycles on his own authority.
    As regards the virtue of the equities market when it comes to forecast recession Paul Samuelson questioned their predictability power by saying “The stock markets have seen five recessions out the last two ones” so at contrario equities market are not reliable forecasters.
    We are back to the yield curve and its solace virtue and the answer is:
    YES THIS TIME IT IS DIFFERENT it has no more predictive value as it has been proved by the facts, inverted since almost 2005 through abusive trading. It has lost integrity which is always to be confirmed through statistical correlation close to 1.
    The assumptions will now be “everything being unequal and remaining so” and the field will be opened to other recession leading indicators which are plentiful.

  8. cb commented on Jan 8

    The argument that tax cuts have lifted the economy seems strange given the magnitude of the other economic stimulus applied since 2001. The lower interest rates probably resulted in up to ~1 trillion/year in economic activity in the US and around the world, in addition we have seen massive government spending increases, currently the 2007 budget is 900billion above 2001. The tax cuts (~100-150 billion/year) seem miniscule in comparison.

  9. Macro Man commented on Jan 8

    That these guys have accrued an ungodly amount of FX reserves, the majority of which finds its way into deposits and government bond markets. Not only do these guys invest directly through auctions, but they also allocate money to external managers in extremely large size. Their general pattern of behaviour is to buy the point on the curve that delivers the highest yield, which generates a structural flattening of the yield curve.

    Their deposits, incidentally, are one of the reasons that broad money growth in reserve currency economies is so high.

    I am surprised there is no mention of asset-liability management in the post above. Pension funds the world over are short gamma at the long end and need to buy an ever-increasing amount of duration when yields go down. They also appear happy tio take down very substantial amounts of inventory above 5% at the US long end and above 4.25% in Europe. Again, this is an influence that was not around for most of the past 40 years that generates a structural flattening/inversion of yield curves.

    The UK is a good example of this; pension regulations changed in 1997, and the yield curve has been inverted for most of the time since. The UK has not had a recession since 1993, incidentally, despite having a property market that is even more expensive that in the US.

  10. winjr commented on Jan 8

    “Their deposits, incidentally, are one of the reasons that broad money growth in reserve currency economies is so high.”

    Isn’t this the Austrian definition of inflation?

  11. Steve Kline commented on Jan 8

    It seems that the significant drop in the fed funds rate yr/yr from mid 2000 to the end of 2001 was a major contributor to consumer spending, especially durable goods (If I new how to get a chart so all of you could see it, I’d show you.) However, the effect of the rate drop was significantly dampened compared to rate drops of during the last 40 years by slowing real average hourly earnings. Someday soon I’ll have some of these charts on our company’s web site, but unfortuntately I don’t yet.

    Below is an interesting chart regarding long-term rates and the stock market. Long-term rates look to be starting an upswing which would lead to significantly lower returns.


  12. Macro Man commented on Jan 8

    Well, it is inflationary for their domestic economies, because these guys need to print domestic currency with which to buy dollars (and euros, and sterling, etc.) , and in many cases the costs of sterilizing are becoming onerous. It is inflationary in the reserve currency economy insofar as bond yields are not priced at a private sector market clearing rate.

  13. Teddy commented on Jan 8

    I know that Art Laffer’s voodoo led to budget, trade, and current account deficits for this country, AND A CONCENTRATION OF WEALTH IN THIS COUNTRY WITH ITS CONSEQUENT AND NECESSARY SECULAR LOWERING OF INTEREST RATES TO ACCOMMODATE THE FORMER MIDDLE CLASS, WHO WERE THE RECIPRIENT’S OF THE RECIPROCAL, STAGNANT WAGES AND A PARABOLIC RISE IN DEBT. And to rationalize this stealthy stealing of the wealth from the former middle class and the wealth of our country, they called it a “global economy”. All other “global country players” are nationalistic, prefering to steal rather than buy American technology, and do not share their high end, value added technology, ie, are basically mercantilistic. And if these mercantilistic countries, including Japan, make direct investments in the US and other countries, it’s for assembling lower end technology.

  14. Fred commented on Jan 8

    Barry….It’s ALWAYS different!

    Macro Man makes good points to which I’d add — Our bond yields are among the highest in the world, and petro $$ and Chinese $$ are happy to buy our long bond (adding to the inversion).

    You should have also gone further on your mention of ECRI, (among the most accurate at predicting recessions) who now see little chance of a recession.

    Recession??…with tight credit spreads, a robust CP market, tight labor market (and rising wages), massive liquidity (private equity pools, flush corporate balance sheets, and large cap ex on the horizon.

    I think not.

  15. Michael C. commented on Jan 8

    Anyone follow the Weekly Leading Index from the Economic Cycle Research Institute.

    It is at its highest point in 6 months. From a trough of -2% to +4%.

  16. MarkM commented on Jan 8

    “…. and large cap ex on the horizon.”

    Can’t this sop finally be taken away? It has served it’s foul purpose. Be gone with you!

  17. Fred commented on Jan 8

    Vista, IPv6, Wimax, CRM….do your homework son, and turn off CNN.

  18. Gary commented on Jan 8

    I’ll add another factor to the recession/sharp slowdown side. Looking at a multi year chart of commodities, the CRB, Oil, Copper, Heating oil, Gasoline & Natural gas all look like they have entered into a bear market. Silver & gold are still looking good. Although gold is starting to look questionable. Lumber, sugar, coffee, cotton, and wheat are all falling. If wheat is leading I would think that corn and soybeans would soon follow and they do appear to be topping after very strong moves recently. Cattle seems to be holding up (possibly due to the severe weather in CO this winter) but hogs have rolled over and are in steep decline. Almost everything that makes the world go round is falling and most are falling rapidly. You could blame the decline in oil on the warm weather but it did start in July and Europe has not had a mild winter like the US. Why would almost every other commodity be collapsing unless demand has fallen off a cliff. The simplest explanation I can think of is the global economy is either rapidly decelerating or we are already in the beginings of a recession. I doubt that the central banks around the world are withdrawing any liquidity so the fact that commodities are still collapsing in the face of strong monetary inflation does seem ominous.

  19. Fred commented on Jan 8

    Acually, commodities become the love child, the “can’t lose” trade, for all the newbie hedge funds….a very crowded trade.

    Amaranth gave them a whiff of reality, and the selling has continues…they levered heavily into very small markets.

    Commodities, the dollar, and bonds are now moving into their “right” or correct levels.

    Long Goldilocks

  20. lurker commented on Jan 8

    Then there is Mr. Laffer’s name, which constitutes a wonderful example of truth in advertising…

  21. spencer commented on Jan 8

    Since WW II an inverted yield curve was also a great stock market sell signal.

    Since the inverted yield curve has not been accompanied by a bear market this time — a very unusual event — it probably is not signalling a recession.

    In the 19th century we commonly had market “panics” when short rates was soar to 50%, 100%, 200% for very short periods.
    These financial panics or inverted yield curves almost always preceeded recessions.
    Remember, the reason the Fed was created was to deal with these financial panics and to keep them from spreading to the real economy. But also remember in that era most businesses operated with “call” loans that the banks almost always called when one of these financial panics happened. This forced firms to raise massive liquidity in a way we have not seen in the last century.

    Always look to see how the structure of markets have changed before you apply the lessons of earlier eras to the current environment.

    One of the ways the current market structure has changed is that the massive inflow of foreign capital has sharply reduced the feds ability to manage the economy. That shift in market structure is probably why an inverted yield curve is not working the way it use to.

  22. Darin commented on Jan 8

    It seems that both arguments (your’s and Art Laffer’s) are grounded on the same assumption: increased money supply. I wonder if there is a model for accuracy for inversions as indicators of a recession that factors in levels of market lequidity through various asset classes?

  23. Fred commented on Jan 8

    “One of the ways the current market structure has changed is that the massive inflow of foreign capital has sharply reduced the feds ability to manage the economy. That shift in market structure is probably why an inverted yield curve is not working the way it use to.”

    BINGO! Spencer nails it.

    Flat world despite its denials. The old models don’t work any more.

  24. Gary commented on Jan 8

    “This time is different” The four most expensive words in investing. Human nature never changes. Until it does I doubt this time will ever be different.

  25. lewis commented on Jan 8

    Yes, it is different this time. With all the Asian/oil money driving down interest rates, it has been shown (insert big study by UVA economists here) that interest rates in the US are at least one if not two percent below where they would be without said inflow of money. So factor that back in, and lo and behold, the whole inverted curve disappears.

    And the mountain becomes a molehill, and odds of a recession drop like a rock, which hopefully will land on some dismal dark science folks…..


  26. GLC commented on Jan 8

    He is biased like most of the cheerleaders…he’s got small equity interests in dozens of traditional asset management firms. Nice guy though.

  27. JoshK commented on Jan 8

    I just skimmed this, but I don’t think I saw you mention the point the article brought out re:the low yields on the long end. They mentioned that many people are buying the long end b/c of excess cash.

    That is fundamentally different than previous recessions.

    Was it Mark Twain who said, “History never repeats itself – but it rhymes?”

  28. MarkM commented on Jan 8

    CNN? Never watch it Freddy Boy and not likely to subscribe to whatever investment newsletter you’ve fallen in love with. The trend in capex has been DOWN for awhile now but, like you say, there’s always HOPE. I just don’t invest in it.

  29. M.Z. Forrest commented on Jan 8

    I think we can all agree that reserves held in the East and Oil states are a new factor. The problem comes in treating them as an assumption. Neither the East nor the Oil States have as a mandate ensuring full employment and economic growth in the U.S. This is not to say that they are disinterested in the same, merely that their interests in these are contingent upon their own agendas.

    I believe we are seeing stress in the system. For example, the imbalance has basically caused Airbus to implode. It is amazing what billions of dollars in aircraft purchases will do for a declining dollar. Some will attribute Airbus’s misfortunes to poor management, but it is hard to compete when your biggest rival discounts their aircraft 20% without any adverse impact upon margins due to the dollar devaluation.

    In so much as this relates to yield curve inversion, I agree that it is not an indicator of liquidity issues.

  30. alexd commented on Jan 8


    The sample for the inverted yield curve is small. I suspect that unless it is tied in with other aspects of measured economic activity that it is insufficient.

    Housing is interesting. The question that is going to tell us something is affordability. If people cannot buy people cannot sell. If people cannot sell some will have to sell and become more competitive in their pricing while others will wait. If sufficient numbers are waiting we have stasis for a given period of time. I suspect that in places like CA and NYC that is what is going to/ or is happening. After all the weather in CA is better than a lot of places. So in a very very general sense it is all beachfront property. NYC has aspects of that too. Manhattan is a more interesting place to live in than Detroit. Looks likely to remain that way for the foreseeable future. So Manhattan has greater cultural phenom propping it up than Detroit. (I live 50 miles from Detroit and have lived right by Manhattan and believe me I am right on this.) Detroit for a variety of reasons including the one stated is the foreclosure capital of the USA.

    But affordability and utility are important factors. The commodity prices should not be lumped together. There is a big difference in the markets for Precious metals versus metals of utility. People bet on the effects of different things that might move price. Copper is housing and manufacturing. Gold is jewelry and paranoia.

    But a hog versus wheat is real odd. Meat on the hoof costs more in terms of energy than plants. But everyone must eat. So if the world is less liquid the price of wheat is going to be propped and the piggys are soft. Corn is currently in flux due to the fact that in the US we seem to be stuck on corn for inefficient ethanol production so that props corn. Animals also eat corn so that too props corn. Less animal production usually weakens corn to a greater extant but demand is propped. Also let us talk about storage.

    Anyone ever hear of the whiskey rebellion in the USA. First time General George Washington has a chance to pound the hammer on framers who did not want to pay a whiskey tax. Whiskey is a much more efficient way to store the corn’s value. Doesn’t go bad and is more compact. If I had the means to efficiently change corn in alcohol I would really be into it. As long as I could get a decent price.

    It is the crops that the farmers will choose not to grow versus corn that will rise.

    Soy might be displaced causing a rise in its price. If we have less of it while demand goes up…. Remember piggies cost more!

    So lumping all commodities together is questionable.

    Transportation check out the new GM car that gets about 100mpg. They will make this sucker when the battery tech is up to par. I give it 3 years. We are already seeing Samsung working on li ion batteries with great capacity and fast charging. Then another 5/7 years for that tech to seep onto the world. Then less oil will be needed. More people will charge via power outlets.

    Buy uranium.

    I think affordability of housing beats the yield curve. And that ties in with the real wealth of the middle class. If we overspend and make the middle class foot the bill then affordability goes down. Because there is less money for the middle class, if their real costs go up in such things as health care, energy, education, housing then they will cause borrowing to increase. Which keeps rates higher than not. When they reach saturation then the front of the yield curve will come down, as we will have a recession like situation, and the long yield will rise with great demand for more interest from borrowers who feel shaky about our economy.

    So I suspect we have a situation where the patient is not bleeding fast enough for a tourniquet but they are weakened and getting worse.

    The things that can change this are amazing technologies, giant golden asteroid hits and unpopulated area, and changing demand equations caused by different and more a efficient approaches to getting things done.

    So bet on really cool tech, services in high demand, and commodities where demand will remain or go higher due to necessity.

    For the short term play it anyway you like, cause it is likely to go all over the place

  31. Macro Man commented on Jan 8


    A couple of points. China has as much as, if not more than, a vested interested in full employment than the US. Urban migration in China is a very significant public policy issue, and the powers that be, in order to stay in power, have adopted policies designed to provide jobs for all the farmers moving to the coast. Part of that policy prescription is maintaining a ‘competitive’ exchange rate, which means buying USD/selling CNY. It is very difficult to seeing that end in the foreseeable/investable future.

    A consequence of this reserve accrual is that they are persistent buyers of euros, which has helped drive the EUR/USD rate to overvalued levels, thus crippling Airbus. That the French political establishment has been vociferous in moaning about the exchange rate in the run-up to this year’s elections is, I think, quite telling.

    Nevertheless, it is not clear that this (Airbus’ woes)has anything to tell us about the shape of yield curves, other than that they have the same root (or one of the same roots) as the decline in yield curve slope.

  32. Michael C. commented on Jan 8

    Money supply is now increasing at an annual rate of over 10%.

    Is anything else even close to trumping this?

  33. Gary commented on Jan 8

    hahahah. I’d have to point out that every time it was “different this time” the market could always find assorted factors to explain why it was different that time but in the end human nature always runs its course.

  34. Alaskan Pete commented on Jan 8

    I think a couple of things need to be added to any current analysis of the yield curve:

    1. What are the impacts of asian central bank purchases. Specifically, do they prefer certain a duration? And how does that preference impact the curve in light of availability of those durations (see 2 below). Given the huge deficit we are running and consequent large “recycling” into treasuries, this could factor in.

    2. Somewhat related to number 1 above, What are the impacts of the constraint on the 30y that occurred when the treas stopped issuing them for a while?

  35. Charles Butler commented on Jan 8

    Macro Man…

    Keep in mind that a good part of what’s crippling airbus is the fact that they can’t deliver the 380, for which Boeing has no competing product. Management is a big issue here. And as for France in general, the country couldn’t get its economy to function when the Euribor was at 1.75% because corporations will not invest in a nation that defends its peoples right to not work at all unless their job guarantees them employment for life. Interest rates and the euro have not hurt them at all (seeing as the situation hasn’t changed) but the politicians are now taking a shot at the ECB in the runup to an election because the one who tells the truth will lose the vote. Pure electioneering convenience.


  36. Macro Man commented on Jan 8

    Alaskan Pete: Central banks tend to buy the highest yielding spot on the yield curve; when the curve is inverted, they’ll buy 2’s (as can be seen through the indirect bidding at recent 2yr auctions); when the curve steepens abit, they’ll buy the belly or towards the back end.

    The A380 explains some but not all of Airbus’ woes. They are getting their clocks cleaned on existing models. One reason for this is that when EUR/USD first crossed 1.30 in 2004, the effective hedge rate of EADS was roughly 1.00. Those hedges have now rolled off, so their effective hedge rate is much closer to the current spot rate.

    France was actually one of the better looking European economies over the past few years; it’s only recently that it’s hit the wall.

  37. M.Z. Forrest commented on Jan 8


    That is indeed the conventional wisdom. I just don’t buy it. Airbus seems to be the worst example you could choose for arguing French market conditions. Airbus is for all practical purposes a state company. Additionally, the skill sets required and national security would make outsourcing less than desirable.

    The reason I picked Boeing and Airbus is that whenever there is significant dollar pressure, some foreigner annonces they are buying $x billion in aircraft. It is an easy way to unload dollars.

    I wasn’t claiming China was disinterested in our employment situation. Their interest is contingent as you further argued.

  38. Banker commented on Jan 8

    I have been reading alot on the inverted curve lately also, and seeing many varing opinions on its outcome. It will be interesting to see how it plays out.

  39. winjr commented on Jan 8

    “It is inflationary in the reserve currency economy insofar as bond yields are not priced at a private sector market clearing rate.”

    Do you mean to say that the long bonds are incorrectly priced?

    Why would a long bond investor want to hold long bonds (vs. short bonds) at these rates, when inflation under the Austrian definition has run amock? As a long bond holder, am I being adequately compensated for the long-term risk of inflation and volatility? Doesn’t seem to me that I am; do you agree?

  40. foo commented on Jan 8

    One other point regarding the “tax cut explains all growth fallacy”. Suppose the tax cuts were 1.5 trillion. This amount does not simply add 1.5 trillion to GDP. You have to take into account the GDP effect of taking 1.5 trillion away from the government. (Remarkable as it may seem, but government spending is part of the economy too.)
    Any positive effect on GDP relates to efficiency gains from having more funds in private hands. This is, at best, a modest positive effect. As income inequality increases, the net effect can turn negative as the welfare increasing actions of the private sector players move from “growth seeking” investment to “protecting my wealth” investment. Consider medeival Europe for examples of economies that got stuck in this latter state.

    Laffer’s ideas are always ideology based. A real-world economist he is not.

  41. pjfny commented on Jan 8

    Central banks also have fiduciary responsibilities……the only reason to buy the long end versus the short end, is if you believe in sharply lower short term rates (which would only happen in a real slowdown/recession). The bond mkt is largely a professional mkt with little retail…the stock mkt is more retail inflow…my bet is on the bond mkt.

    The only part of your argument i buy is a structural change in pension fund matching of asset/liabilites as the baby boomers retire (buying the lond end).

  42. Teddy commented on Jan 8

    winjr, as the trade and current account deficits increase, the creditor nations can buy one more dollar’s worth of our bonds, and they will get another dollar’s worth of our good paying jobs. And with the huge annual trade and current account deficits, more of those good paying jobs are leaving as I write this. Big reaction today in TLT to the “huge” job growth numbers reported on Friday. Negative real interest rates can coexist with stagflation for a time and be prevented from causing a moonshot into hyperinflation if the jobs and money flow swaps are in a somewhat dynamic state of equilibrium. Any sudden shift in REVERSE direction could lead to disastrous results.

  43. jagmohan swain commented on Jan 8

    Inverted Yield curve is an indicator.And like any indicator this one may fail.I am more concerned about the connotations of yield curve, what causes it and how it impacts the economy.If the only impact of an Inverted yield curve is discouraging banks from lending money so as to create a credit contraction which in turn facillitate a recession then the impact of an inverted yield curve is going to be very limited this time around.I haven’t seen any evidence of credit contraction, even the rising Fed rate is unable to do so ( Which is a smokescreen by itself played by Fed ).The biggest buffoons are the bond market participants who took the long yields to such ridiculous levels and being fooled in the process.

    Continued expansion of credit means economy could expand longer albeit at a tepid rate.Stagflation is the apt word in my view.

    M3 is exploding everywhere. In emerging markets such as India , china M3 growth is even faster than America’s.So if you are looking at currency market to find evidence
    of dollar devaluation you won’t see any.Commodities and gold in particular would
    be the best gauge of dollar devaluation on the long term ( short term is mere noise).

  44. Charles Butler commented on Jan 8


    Yes, but the structural problems that are at the heart of the French malaise have been around, and recognized, for years. You don’t get the French unemployment numbers of recent times in a resilient economy during a global boom. The fact is that it is politically impossible to correct them on the domestic level. Witness the failed attempt to free up the labour market in 2006. The solution? Ignite inflation in the countries that are providing growth in the EC, and probably to no benefit. Uh-huh.

    The A380 isn’t everything, but is probably the difference between a rough patch and Airbus’s effectively bankrupt condition.



  45. MDDwave commented on Jan 8

    My look on recent periods of inversion
    1) 1978 to 1982 when interest rates were so extreme, that there was no demand for long term loans.
    2) 1989 when Savings and Loans crisis/debts had to be settled.
    3) 2000 when the stock market bubble collapsed.

    and 4) 2006-2007 when the Fed ramped up rated to 5.25.

    If one calculates the relative difference of interest rates [(long term – short term)/long term], the recent inversion mostly matches 1989 inversion.

    There is still a difference between the two. In 1989, long term rates were higher and significantly increased (7-9) prior to inversion whereas in 2006 long term rates are essentially the same (4.5). In 2006, it still seems that a correction needs to take place to correct for the long period (4 years) were there was large difference between short term (1-2%) and long term (4-5%).

  46. donna commented on Jan 8

    Yeah, it’s different. We used to be a creditor nation, now we’re a debtor one.

    Selling the country, one piece and job at a time…

  47. Macro Man commented on Jan 9


    The French are hardly unique in Europe in the regard of not having flexible labourm markets.


    In my experience ‘investment authorities’ are highly sophisticated investors who account for risk premia and the fiduciary responsibility that you allude to above. The SAFEs of the world are populated by bureaucrats with no mark to market accounting who take the simple view that they will buy the thing that yields the most. A perusal of the TIC data will confirm that CBs do, in aggregate, trade around the curve.

  48. Tom Graff commented on Jan 9

    I argue that the inversion merely points to a likelihood of falling short-term rates. The fact is that historically, falling short-term rates normally coincides with a weak economy. This isn’t because of some iron law of economics, its because of how our central bank works.

    So if the Fed cuts several times and averts a deeper slowdown, then the curve was right to invert but we still get no recession. I’d argue that wasn’t a false signal. I’m also not claiming “its different this time.”

    In fact, its exactly the same as its always been. When the Fed is likely to cut short-term rates, the curve will probably invert. The relationship to recessions is indirect.

    See: http://accruedint.blogspot.com/2007/01/grading-wsjs-understanding-of-yield.html

  49. pjfny commented on Jan 9

    1.If central banks buy the long end of the US curve, they most believe short rates are coming down (implying as slowdown/recession), depite their collective rhetoric,that the world economy is doing fine.
    2. We have not yet solved the issue of avoiding recessions, certainly not with one crude measure (short term rates). Recessions come from overcapacity, inventory buildup cycles, consumer cutbacks, change in risk perceptions etc etc that cannot be solved lowering rates….
    3. When was the last time the collective community of economist/strategist predicted a recession(never).
    4 with housing in recession, auto ind in a real slowdown,manufacturing in decline,consumer funding consumtion with borrowings (neg sav rate) etc etc….if this does not lead to a recession, what will???

  50. Macro Man commented on Jan 9

    The central banks who buy US bonds make relatively few comments on the global economy. And again, they buy the point on the curve that pays them the most because they don’t have to mark to market. There isn’t necessarily a view attached to that (w.r.t. the likes of China. The Middle East and Norway are much different.)

    I would argue that one of the things likely to prevent a recession is one of the factors you cite: the inventory cycle. Inventory management is substantially better than it used to be, and manufacturers respond to demand shortfalls more quickly than was the case in the past. While this can be taken as “proof” that recession is on the way, it actually makes recession less likely in my view. There has recently been a big jump in the inventory/sales ratio to 1.31….which is lower than any reading in history before February of 2004.

    I beleive that one of the big surprises of 2007 will be the degree to which net exports contribute to GDP growth. Think about it. Lower energy prices reduce the import drag, and for once domestic demand in the RoW is substantially higher than in the US. Meanwhile, some US firms find themselves sitting in the catbird seat, thanks to the competitive $, e.g. Boeing per the discussion above.

  51. pjfny commented on Jan 9

    I agree that most CB buy the more liquid part of the curve (the short end), but that by extension means the demand for the long end is from private demand…which imlies that the bond mkt as a whole thinks we are going into a recession( lower short term rates by approx. 50-100bp).
    I do not for a moment think that we have solved the recession issue, by better inventory control……usually what happnes is demand falls of a cliff inv/sales ratios balloons and the production numbers takes some time to change.
    the problem with net exports as a driver, is the fact that most of the fast growing economies of the world are export driven not comsumtion driven (asia). They have very little inclination to buy our goods.

  52. Tom Graff commented on Jan 9

    My only point is that if the Fed is looking to cut rates, the curve may well invert. Regardless of why the Fed is cutting rates. I’m not trying to argue against a recession, and absolutely not arguing that the Fed can avoid recessions simply by cutting rates.

  53. Fred commented on Jan 9

    The $$, commodities, interest rates, and even the VIX are all coming back to the “right” levels….the levels before the dislocations of the currency blow ups, the late 90’s (aka “the era of lies”), the subsequent tech bubble and crash. Now the the (flat) world is here, millions of new consumers are being brought into the global market place. Capital will flow where it’s treated best (not Caracas!) and Central banks need to start acting together, to create balance in trade and consumerism. Older / mature economies must also “re-tool” their education systems to keep up with the new world. Sitting on your butt, earning inflated wages for “make work” positions are obviously doomed in the new “productive” world order. Entrepeneurs are essential, and need to be encouraged — economically, and otherwise. Our schools must focus on the next generational needs.

  54. Barry Ritholtz commented on Jan 9

    Wrap your heads around this: Do Yield Curve inversions cause recessions, or are they correlative to something else that is causing a recession?

    Follow the logic: Economies are cyclical — towards the end of the cycle, the Fed raises rates to cool inflation, slows the economy, inverts the yield curve, and — voila! — causes a recession.

    So is it the inversion, or the Fed, that’s to blame? It may not matter, because the inversion is merely evidence of what the Fed is doing . . .

    So we can easily argue it is not the inversion that causes recessions, but its evidence of other forces that might . . .

  55. Macro Man commented on Jan 9

    Why should an inversion necessarily cause a recession? What is the economic cause and effect there?

    Inverted curves typically accompany recessions because (profit-maximizing) private sector agents who identify a slowing economy before the central bank buy duration, causing the long end to either sit still or reverse course even as short yields are rising. In advance of the last recession, for example, 10yr yields peaked in January 2000, despite 75bps more tightening from the Fed that year.

    I would argue that because of central bank reserves and asset-liability management, the people buying duration in 2006 were not nearly as ‘profit-maximizing’ as they had been in past cycles. As such, one should at least question the information content of the yield curve. As I mentioned above, inverted curves have singularly failed to forecast recession in the UK, Australia, and New Zealand.

  56. Fred commented on Jan 9

    Agree MM, and would add the Leading Economic indicators are clearly pointing away from a recession (in addition to all the other “tells” I’ve mention repeatedly).

    The world HAS changed..to a flat one. I imagine you agree on this basic point. Therefore the global flows have changed, and are effecting GLOBAL yield curves!

    I’ve enjoyed the spirited (and generally cival) discussion of this imortant thread!


  57. BDG123 commented on Jan 9

    Do inverted yield curves cause recessions? Does a bear sh*t in the woods? Well, only if traditional lending is required to create liquidity for the economy. At some point it is. But, since liquidity can and is created via other methods and credit instruments, banks are still able to loan to consumers at inverted rates and still make a killing. There are also other methods of raising capital in today’s markets for business as well that aren’t affected by inversion. Couple that with rising wealth and too much cash equivalents sitting in short term accounts which themselves creates liquidity and you have a lesser impact caused by inversion….temporarily. In the end the fundamental issue still applies. Inversion counts and does brake the economy. In each cycle there may be differing factors. Maybe it’s too much liquidity which Greenspan articulated a decade ago when he pushed and pushed but could not get rates to budge. Or maybe the markets clearly understand and have since the late 1990s that the only way out of this is asset corrections and longer term inflation was a ruse. That is, unless the Fed has a death wish which they cleary don’t have.

    But, I would bet Art Laffer everything I own if he bets me everything he owns the market is not going up 67% before a major correction. The markets haven’t gone up more than 67% in the last five years combined. I am so tired of these mindless morons. And to think he served a President. The older I get the more I realize those running the zoo aren’t any more able than the animals in the zoo.

  58. CMC commented on Jan 9

    Why are corporate bond spreads so low, which seem to indicate high level of confidence in the economy? How did corporate bonds behave prior to past recessions? It seems that corporate bond buyers and treasury buyers are betting on different outcomes. Or is there just so much liquidity driving up prices in both markets?

  59. Fred commented on Jan 9

    Corp spreads always widen going into a recession (ability to pay gets questioned). CP market also gets hit..harder to raise $$. Yes..(global) liquidity is driving the bus.

  60. BDG123 commented on Jan 9

    Corporate bond spreads DO NOT widen ahead of recessions. Bond spreads will widen only when the sh*t hits the fan.

  61. Charles Butler commented on Jan 10

    The distant bond maturities assume that economic cycles will come and go. The presumedly higher interest they should offer reflects, mostly, political risk. In fewer syllables – war. That the curve is inverted is self-explanatory, but the anomaly is at the long end, not the short.


    Couldn’t agree with you more on the exemplary nature of the commentaries. Maybe it’ll start a trend.

  62. Fred commented on Jan 10

    BDG… I will enjoy being on the opposite side of your trades…like taking sweets from a child.

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