In the summer of 2004, bond yields (interest rates) regularly fell on reports of higher oil prices. My other favorite recent fashion in economics dates back two years. However, this line is apparently no longer in fashion, or at least not in the business pages of the country’s major newspapers. With the 10-year Treasury bond rate hovering at 5.0 percent and the Federal funds rate at 5.25 percent, we might expect the inverted yield curve folks to be warning of impending disaster. Whether the short-term rate stays 0.1 percentage point above or below the long-term interest rate cannot possibly make any difference when it comes to the probability of a recession. It is not the inverted yield curve that causes the recession it is the fact that the Fed raised interest rates by too much. Sometimes the Fed goes too far and throws the economy into a recession. Inverted yield curves almost always (I say “almost” in case I missed one) come about because the Federal Reserve Board raises short-term interest rates in an effort to slow the economy and raise the unemployment rate. There is no mysterious incantation that leads an inverted yield curve to do any special damage to the economy. This discussion made for painful reading. A few months back, as the Fed was raising short-term interest rates, without much increase in longer term rates, many market analysts raised the prospect that the yield curve would become inverted and that the economy would therefore sink into recession. This reverses the normal course of events – typically investors expect to get a higher rate of return if they agree to lock up their money in a long-term bond or time-lock account rather than keeping it in a checking account where they can get immediate access. This seems worth mentioning now because the yield curve is becoming seriously inverted as long-term rates have edged downward, even as short-term rates remain relatively high.įor those who have better things to do with their time, an inverted yield curve refers to a situation in which short-term interest rates are higher than long-term interest rates. An inverted yield curve was supposed to signal an upcoming recession. Remember the inverted yield curve and the hoola hoop? A few months back, the prospect of an inverted yield curve was seen as an ominous warning sign of bad times ahead.
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