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Is a Recession on the Way?
By JLP | January 9, 2007
There was an interesting article in today’s Wall Street Journal about the inverted yield curve ($) we are currently experiencing. For those of you who don’t know what an inverted yield curve is, let’s start by first understanding what a normal yield curve looks like.
In a typical interest rate environment, the longer a bond investor has to wait for their bond to mature, the more they demand in interest payments (or yield). In other words, they want to be paid more for tying up their money for longer periods of time. In this case the yield curve might look something like this:
Now, contrast that with an inverted yield curve. In this case, short-term bills yield more than longer-term bonds, causing the yield curve to become inverted and look something like this:
The reason this is important is because an inverted yield curve can often be a sign of a coming recession. According to the Journal article:
When bond investors see a recession coming, they tend to buy long-term Treasury securities for two reasons. First, they are safer than stocks. Second, they are appealing when inflation is low, and recessions tend to beat down inflation. The buying that comes with recession fears drives down a long-term bond’s yield, sometimes below the prevailing yield on short-term Treasury securities.
Even more troubling…
Seven times between 1965 and 2005, yields on the 10-year note have dropped below those on the three-month Treasury bill for an extended span. In six of those instances, the U.S. economy went into recession soon after.
Interesting…
Topics: Investing |
