Thursday, November 02, 2006

Is the Treasury yield curve forecasting an imminent recession?

Rex Nutting has a nice article on MarketWatch entitled "Recession odds growing, Fed model shows - Yield curve model shows 50% odds of slowdown", but the real conclusion is not as clear as the title suggests. In fact, the last section of the article has the heading "Yield curve not enough."

He closes with a great quote from Fed Chairman Bernanke:

Policymakers should monitor bond yields carefully in judging the current state of the economy--but only in tandem with the signals from other important financial variables; direct readings on spending, production, and prices; and a goodly helping of qualitative information.

My view is threefold:

  1. There are in fact a lot of investors who really do think a recession or major slowdown is coming and they have bought boatloads of Treasuries to bet on that outcome, and that by definition helps to invert the yield curve.
  2. Many retirement and pension investors need safe, long-term fixed income investments, also pushing down long-term yields, regardless of the short-term economic outlook.
  3. Lower long-term yields result in lower borrowing costs for consumers and businesses, helping to keep the economy floating higher.

Lakshman Achuthan of the Economic Cycle Research Institute (ECRI) is quoted in the article. He really knows his stuff, especially leading indicators. He states it simply: "The yield curve doesn't pass our test to be included in our leading indicators."

In any case, it is a good article that covers a lot of the bases fairly.

To answer my headline question: Is the Treasury yield curve forecasting an imminent recession? Short answer: No.

-- Jack Krupansky

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