View Full Version : Yields signaling recession coming

12-27-2005, 03:45 PM

NEW YORK (MarketWatch) - Treasurys were higher Tuesday after the spread between the 2-year note and the 10-year note inverted for the first time in five years.
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An inverted yield curve occurs when short-term maturities pay a higher interest rate than longer-term maturities.

Such an event has typically foreshadowed a noticeable downturn in the economy and, usually, a recession. With an inverted yield curve, banks can no longer make money by borrowing short-term money and lending it at longer terms.

The inversion first came in European trade when the 2-year note yielded 4.411% versus a 10-year yield of 4.405%. The curve briefly inverted in late morning trades, with the 2-year note yielding 4.377% and the 10-year yielding 4.373%.

Treasurys continued to rally modestly throughout the session.

In recent trades, the yield curve normalized with the 2-year yielding 4.351%, while the 10-year yield stood at 4.367%. Still, a large part of the yield curve was still inverted, with 5-year notes yielding 4.309%, just 6 basis points more than the overnight federal funds rate of 4.25%.

"The market has been pressing for curve inversion for several weeks," said economists at Action Economics, who said they expected it would be a temporary development.

The last time the yield curve inverted was in 2000, before the last U.S. recession and a period of aggressive rate cuts by the Federal Reserve. The yield curve briefly inverted in 1998 during the Asian financial crisis, the only time in the past 30 years that an inverted yield curve has not preceded a recession.

Some economists continue to eye the yield curve as a critical economic indicator. Others say it's lost its usefulness because special factors, such as the government shifting issuance to shorter maturities, have distorted the curve's economic signals.

An inverted curve doesn't cause economic weakness, although it has been correlated with weakness in the past, said Bill Dudley, an economist for Goldman Sachs. He argued that tight monetary policy is the underlying cause of most slowdowns.

"The question you have to ask is: Do you think monetary policy is really too tight?" Dudley said. "I don't think it is."

Dudley, along with most other economists, is forecasting a slight slowing of growth next year as the housing market cools. The consensus forecast calls for 3.4% growth in 2006, down from an estimated 3.6% in 2005, according to Blue Chip Economic Indicators.

The Fed too has played down the bearish implications of inversion, although "many in the market are much less prone to shrug it off," said Action Economics.

Still, "the backdrop of robust growth and benign inflation suggests that the market is not signaling a slowdown in growth which has been the case in prior curve inversions," Action said.

Federal funds futures markets anticipate two more rate increases from the Fed, which would put the target rate at 4.75% by March.

With no economic data on tap Tuesday, the market focused on supply.

The government auctioned $21 billion in 6-month notes at a discount rate of 4.20%. The bid-to-cover ratio was 1.99. The government also auctioned $23.5 billion in 3-month notes at a discount rate of 3.905%, with a bid-to-cover ratio of 2.18.

Treasury also said it would auction $20 billion of 2-year notes and $10 billion in 4-week bills later this week. The proceeds from the two auctions will be used to pay down about $16 billion in debt.

Elsewhere across the yield curve, the 5-year note was yielding 4.31% and the 30-year was yielding 4.53%.

12-27-2005, 04:39 PM
I don't get it.

According to this article from SmartMoney.com called The Living Yield Curve (http://www.smartmoney.com/onebond/index.cfm?story=yieldcurve), an inverted yield curve occurs when long-term investors are willing to settle for lower yields now because they think rates and the economy will go even lower in the future. Hence, they're betting that this is their last chance to lock in rates before the bottom falls out.


But in the past all of the inverted yield curves have occurred with long term bonds yielding much higher rates than today. Why on earth would anyone want to lock in 30-year rate in the low to mid 4%s?? Historically, 30-year interest rates have never been that low. To think they're heading lower seems like an unrealistically pessimistic view of the future.

12-27-2005, 11:36 PM
how does this effect money market accounts?

12-28-2005, 01:59 AM
it doesn't for now, if the fed is smart they won't lower rates to head off a recession and instead force the govt to control spending

12-28-2005, 10:15 AM
The yield curve from 2-10 has 2 yrs being a basis point or two higher than 10 yrs(temporarily I might add looking at yesterdays closing prices) and this ipso facto necessitates a recession? C'mon. The yield curve is basically flat not inverted. Even if the yield curve was inverted it doesn't necessarily mean that a recession is imminent. I will say that the classic conditions for inducing a recession are developing IMO. The economy is quite strong and from what I've been able to discern demand for labor is picking up. What's amazing to me is that the 10 yr is yielding what it is.

12-28-2005, 11:12 AM
it is forecasting a recession as the slowdown in re/lending will trickle through the economy....

12-28-2005, 10:21 PM
I will say that the classic conditions for inducing a recession are developing IMO.

[/ QUOTE ]

What would they be? (A large federal deficit, that looks to increase for the forseeable future?)

12-29-2005, 04:19 AM
ECON 101...look for an inverted yield curve...The only econ question on the series 7 exam... web page (http://news.yahoo.com/s/fool/20051228/bs_fool_fool/113580191016)

12-29-2005, 09:13 AM
But rates are in the low to mid 4's, isn't that awfully low for a recession?