Yield Curve Inversion

Sunday, May 28, 2006 | 08:59 AM

Fed_yield Anyone else notice the brief Yield Curve Inversion this week? The 10-year yield slipped below Fed Funds rate for first time since the last recession.

Chris Isidore of CNN Money has the details:

"The inversion early Wednesday was different than the inversion that occurred late last year and early this year, when the 10-year Treasury yield fell below the yield on shorter-term Treasury securities.

Wednesday's inversion came as the 10-year yield fell briefly below the fed funds rate, the Fed's short-term rate target, currently 5 percent. It was the first time that's happened since April 2001, the last time the country was in a recession.

The 10-year yield dipped briefly below the fed funds rate Wednesday morning after a report showed a big drop in demand in April for cars, refrigerators and other big-ticket items known as durable goods.

But when a report on new home sales came in above forecasts 90 minutes later, the 10-year Treasury yield edged back above the 5 percent level."

I continue to believe an economic slowdown is in the offing as stimulus fades, and the pig moves through the python. Recession odds for 2007 keep increasing. This despite what Ben "CPI overstates Inflation" Bernanke has said:   

"But in recent comments, Fed Chairman Ben Bernanke repeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is no longer a good indicator of a recession ahead.

"In previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint," Bernanke said in a speech in March. "This time, both short- and long-term interest rates -- in nominal and real terms -- are relatively low by historical standards."

Keep in mind that inversions are not binary -- i.e., inversion or not. The depth and duration of an inversion are significant and contain information. The inversion this past Wednesday was "short-lived and relatively narrow. Some of the pre-recession inversions in the past were far more pronounced." Compare this with prior inversions:

"For example the gap between the 10-year yield and the fed funds rate were inverted for nearly 11 months and the gap reached 1.5 percentage points in January 2001, just before the Fed started cutting rates.

The recession that started in late 2000 lasted until the fall of 2001.

Still, an inverted yield curve is not something that can be ignored, the experts said.

"I think it would be healthy to be concerned, given the track record of the curve being a warning sign," said Schlesinger. "It's important not to be trapped by past patterns. But it (the inverted yield curve) does raise a question about how far the Fed has to tighten."


>

Source:
Yields throw the Fed a curve
Chris Isidore
CNNMoney.com, May 24, 2006: 3:35 PM EDT
http://money.cnn.com/2006/05/24/news/economy/fed_yield_curve/index.htm

Sunday, May 28, 2006 | 08:59 AM | Permalink | Comments (7) | TrackBack (0)
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Comments

The Fed never stops until after it has gone too far.

There is a long lag between policy action and the impact from that policy action. We are still partially under the influence of the previous very low interest rates.

The impact from the rate increases of the last 12 months have only begun to be felt. But the impact will come. The current rates are well above the average of the last 2 years. The recent "medicine" has not yet taken hold.

Once again, the Fed has over medicated the patient.

However, they have not overdone it by as much as they usually do. I believe that the neutral rate is under 4%. The rate increases prior to reaching 4% were just reduction of the stimulus. We are now modestly above neutral and should expect a modestly negative impact on the economy.

Hopefully, they will stop and let their policy actions take hold.

Otherwise by next year they will be prescribing the opposite treatment to counteract the over-dose of their 2006 policy.


Posted by: Zephyr | May 28, 2006 1:35:48 PM

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