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Source link: http://archive.mises.org/4490/listen-to-the-yield-curve/

Listen to the Yield Curve

December 27, 2005 by

Because it tells a story. Today, the yield curve inverted. Long-term maturities are now paying a lower interest rate than short-term maturities. In a quote from the USA Today article, the last sentence, er, stands out:

Other economists say the curve has lost its significance because special factors, such as the government shifting issuance to shorter maturities and strong demand for Treasurys from foreign buyers, have distorted the curve’s economic signals.

An inverted curve doesn’t cause economic weakness by itself, 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.


Paul D December 28, 2005 at 7:54 am

Shouldn’t this mean a total collapse of the long-term maturities market? Why would anyone choose them over short-term yields?

Seth Daniels December 28, 2005 at 8:50 am

Bill Gross et. al are predicting deflation and think that long term yields go even lower. I think that’s a tough bet (I’ll take the over: inflation if not hyperinflation), but Bill Gross is a great investor. Also, central banks are not economically motivated and may continue to support the 10yrs.

Siggyboss December 28, 2005 at 9:14 am

Last I remember, the Fed views an inverted yield curve as a clear signal of a future recession. We may see the future Fed Chairman in front of cameras as politicians scream in horror, and look for scapegoats. The statists will then beg for more intervention. Wait? They already do that.

Stefan Karlsson December 28, 2005 at 12:44 pm

I don’t really understand why anyone would want to invest in U.S. government securities of any maturity at these low yields. But there is a certainly a case for choosing long-term maturities over short-term if one believes short-term rates have peaked or will soon peak for this cycle. Having 4.4% for 10-years sure beats having 4.4% just say 6 months and then get only 2% for the coming years.

Jim Berger December 28, 2005 at 1:00 pm

Bond traders might hold long-term bonds, inspite of an inverted yield curve, if they believe long rates will decline further. A drop in long rates would cause bond prices to rise, giving the trader a (sometimes sizable) gain. (This is not a prediction.)

William December 29, 2005 at 8:24 am

My impression is that this is a condition caused entirely by the money system, the Fed. They have artifically increased short term rates above the price the debt markets have established for long term rates. So the short term rates are most likely quite a bit above the “real” short term rates.

It is not a signal of a recession exactly. It is a signal that the economy has incorporated the artifical gains from the increases in currency, by the Fed. So the Fed in its effort to correct for this correction has made the impossible scenario that a short term bond pays a higher rate of interest than a long term bond.

George Gaskell December 29, 2005 at 9:53 am

tight monetary policy is the underlying cause of most slowdowns

I think I remember reading something similar once …

Oh, yes, it was in The Austrian Theory of the Trade Cycle.

Siktath October 28, 2006 at 3:42 am

Actually, most recessions are Intertemporal Money Supply Imbalances. The inversion of the yield curve is just an indication of when this is. Although spikes in the longer term yields are not reliable in predicting exact times when the money supply imbalance will finally manifest itself through negative affects upon output growth, when the 3 month retains the highest current yield, you can be sure that there will be trouble either in the quarter that it spiked or the following one.

What’s interesting is that, historically, the more inflation (monthly annualized CPI) there is, the lower the real yield by US Treasuries. The Fed is simply not managing the correct interest rate(s).

To cure these recessions due to Intertemporal Money Supply Imbalances, the Fed should simply pick an inflation rate it likes, find the average real rate of interest for each security, and try to achieve those real rates per security month to month. We’d enjoy a higher level of price stability and probably only suffer recessions due to major supply/demand shocks.

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