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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 | 13 Comments »
January 9th, 2007 at 1:20 am
Thank you for the graphs. I’d heard the word explanation of inverted yield curves before, but never could quite figure out what it meant. As soon as I saw the graphs, it made sense.
Wasn’t there a scare about this exact thing several months ago as well? Or have bond yields been inverted for a while? I remember hearing something like this on NPR quite a while ago.
January 9th, 2007 at 1:23 am
JLP, this comment above by “Mark Davis” is very interesting although it seems to have digressed from the topic of inverted yield curve.
May be you want to look into it and enlighten us readers.
Thanks for the inverted yield curve information. Cannot help but wonder how quickly and easily your graphs conveyed the information.
January 9th, 2007 at 7:41 am
I have been wondering about this for a few months now. I have been interviewing for new jobs because I feel that in a year or two, we may see a turn in the market, so better get to a better spot quick, eh?
January 9th, 2007 at 8:36 am
Accrued Interest has an interesting analysis of this article here: http://accruedint.blogspot.com/2007/01/grading-wsjs-understanding-of-yield.html, coming to the conclusion that “it seems like the 10-year is priced about right.”
January 9th, 2007 at 10:22 am
Golbguru,
I deleted Mark Davis’ comment as it was SPAM! I guess I didn’t get it quick enough since you saw it.
My question is:
If he makes $600,000 per year off of his website, then why the heck is he hanging out on my little blog?
Of course, we know the answer to that!
January 9th, 2007 at 1:49 pm
JLP,
Good info, well presented. This is an important indicator. Perhaps the most widely followed indicator that tends to preceed recessions/bear markets. To answer Chris’ question, the yield curve has been inverted for several months. The extent and duration of the inversion are also factors that economists/analysts look at.
January 10th, 2007 at 5:58 pm
Nice article!
January 10th, 2007 at 10:00 pm
Hasn’t the yield curve been pretty flat for the last year or so? Seems I read somewhere that banks that borrowed short-term to lend long-term were not getting the interest rate spread that they used to enjoy.
January 10th, 2007 at 10:22 pm
[I don't think those graphs are quite right]
There’s a good tool and commentary on the inverted yield curve at smartmoney:
http://www.smartmoney.com/onebond/index.cfm?story=yieldcurve
The yield curve has been flat-to-inverted for months now, but the rate isn’t as inverted has it was in the early eighties (something like 250 basis points).
January 10th, 2007 at 11:04 pm
One more thing… the yield curve was inverted in 1998 and also in Dec 05 – Jan 06. The economy did pretty well then, although I do believe that the yield curve is a good indicator of a slowing economy or a recession.
January 11th, 2007 at 2:50 am
Gary North, one of my twice-weekly newsletter reads, talks about this a lot. It’s one of the more accurate leading indicators of a recession. Probably this year.
Thanks for the graph!
January 12th, 2007 at 3:07 pm
I’d be shocked if a recession was not on it’s way – at least at some point – regardless of the yield curve.
However the inverted yield curve which has been in place since 2005 and was called a “conundrum” by Greepsance (http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm) has several other factors e.g. Foreign-buying of treasuries etc.
On the positive side – the low yield for 10- and 30-year treasuries means the US Govt doesn’t have to pay so much to service it’s debt which is a good thing for all of us.
-Frank
January 13th, 2007 at 3:26 am
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