Friday, March 20, 2015
No, the yield curve is NOT forecasting mediocre growth. Right now it actually isn't forecasting anything
- by New Deal democrat
A 3 dimensional view of the yield curve in the treasury bond market at the New York Times has gotten a lot of play in the econoblogosphere yesterday.
Why pay attention to the yield curve, i.e., the difference in interest rates paid by short term vs. long term treasury bonds? Here's why: an inverted yield curve, I.e., short term interest rates higher than long term interest rates, is a nearly perfect warning of a recession 12 to 18 months in the future. In the last 100 years, it has had only one false positive (1966).
If we are sure we will have inflation rather than deflation in the next several years, a normally shaped yield curve is also a perfect indicator for the economy about 12 to 18 months later. In times of deflation, however, a normal yield curve is not reliable. An inverted yield curve in the presence of deflation is much to be feared. It has only happened twice in the last century – in 1928 and 2006.