Thursday, February 8, 2007

Yield Curve Inversion Continues

From Caroline Baum of Bloomberg:

Depending on what measure of short- and long-term rates one uses, the slope has been negative for either six months (using the 3-month Treasury bill and 10-year note) or seven months (using the federal funds rate and 10-year Treasury note). A yield curve that slopes upward, with long rates higher than short ones, encourages financial institutions to borrow short, lend long and pocket the difference, promoting economic growth in the process.

An inverted yield curve has been a harbinger of recession in the past. Unless this time is different -- a popular way of dismissing the spread's stellar history -- real gross domestic product growth of 3.5 percent in the fourth quarter may turn out to be the outlier, not the trend.

This is a really long time for an inversion to continue. And it begs the question, "is this inversion different than past inversions?" After all, 4th quarter GDP came in at 3.5%, and unemployment is low, indicating a recession isn't on the horizon yet. Or it's been averted for awhile.

I don't have an answer for the above statements. What I think is the "this time is different" argument does not play well with historical evidence. As Baum also notes this indicator is not the "hemline indicator". There's a fundamental reason for the inversion. And until the inversion goes away, we should pay attention to the yield curve.