When long term rates are lower than shorterm rates- the interest yield curve is inverted...yep! and we are there...this typically indicates a slow down- I'm already slowed down!

Date:   11/30/2005 11:10:17 AM ( 19 y ago)

NEW YORK, Nov 29 (Reuters) - Short-term interest rates are at the cusp of surpassing their long-term counterparts in the United States, and many analysts are already squirming in their chairs as they worry about an economic slowdown.

In the past, what is known in financial markets as a yield curve inversion -- because longer-term investments start to yield smaller returns than near-term ones -- has often presaged a weaker economy, and sometimes even recession.

That is because an inverted curve shows that long-term investors are willing to settle for lower yields now because they think the economy will slow and rates will go even lower.

Yet officials at the Federal Reserve have argued that a changing global financial landscape has muddied the yield curve's predictive capacity.

In particular, they maintain, excess savings abroad coupled with strong foreign interest in U.S. assets has artificially depressed long-term interest rates.

But a number of economists fear this line of reasoning is a tad rosy.

"The most dangerous words in investing are 'things are different this time around,'" said Robert Fry, senior associate economist at the chemical giant DuPont. "If the Fed were to invert the yield curve I'd be pretty nervous."

The central bank certainly is cutting it close. On Tuesday, 10-year Treasury debt was yielding only 0.06 percentage point more than its two-year counterpart, which in turn had already surpassed yields on five-year bonds .

The last time this happened was in early 2001, just before a stock market slump obliterated trillions of dollars in investments and helped push the economy into recession.

"Any time you have a yield curve as flat as the U.S. yield curve is three months out, it does suggest that the market has yet to be convinced that the economy is going to maintain its vigor," said Steven Englander, chief North American foreign exchange strategist at Barclays Capital.

To be sure, there are others that hold a much more sanguine view of the American interest rate trend, arguing that massive demand for U.S. Treasury bonds from foreign central banks has fundamentally altered the yield curve landscape.

"There are a lot of dynamics at work that are forcing long-end yields lower," said Brian Robinson, a bond market strategists at 4Cast Ltd. "Foreigners are a big part of it, they're not as sensitive to price."

Nonetheless, a number of looming obstacles to continued economic growth in the United States give pessimists credible reasons for concern.

Number one on a laundry list of economic pitfalls is the housing market, where a relentless boom has prompted many to worry about a price bubble.

Much of the blockbuster consumer spending of the latest economic expansion has been fueled by borrowing made against appreciated home values, so any drop in housing prices could take a toll on growth.

And there are other sources of anxiety. Among them is an ever widening trade deficit, which many fear could prompt a sharp decline in the dollar sometime in the next couple of years, making U.S. investments less attractive to foreigners.

So is the yield curve saying those events will soon come to a head? Typically, any slowdown takes place around 18 months following an inversion, give or take.

Whether this message is applicable to the current economic cycle only time will tell, but yield curve loyalists say that investors who ignore its oracle do so at their own peril.





 

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