Monday, March 12, 2007

Yield Curve Says Recession -- Still

From Bloomberg:

The probability the U.S. economy will shrink for two quarters has risen to 50 percent, according to a model created when Greenspan ran the Board of Governors of the Federal Reserve System. The formula is based on differences in yields on Treasuries.

The economy has gone into recession six of the seven times since 1960 that short-term interest rates topped longer-term bond yields, as they do now. The difference between three-month bills and benchmark 10-year notes is close to the widest since 2001. Investors say the so-called inverted yield curve is a sign the Fed will cut borrowing costs because the economy is decelerating.

Here is something that I haven't written about in awhile -- the inverted yield curve. Short-term rates have responded to the Fed's interest rate hikes while the long-term part of the curve thinks inflation is at least in check for now. That means market participants think the economy is slowing and possibly moving into a recession.

The argument can be made that long-term rates are in fact responding to foreign direct investment in the US. However, this argument forgets to acknowledge that these investors wouldn't invest in US debt if inflation was an issue.

The short version is the yield curve is inverted, has been for some time and that is usually a sign of an approaching recession.