WHAT DOES THE YIELD CURVE TELL US ABOUT FUTURE ECONOMIC CONDITIONS?
There are few indicators more prescient than the yield curve. Over the years the curve has successfully predicted all but two post WW2 recessions. In the last 40 years it is 7 for 7 in predicting recessions. A negative yield curve is generally consistent with a Federal Reserve that is attempting to cool the economy. Clearly, they have a tendency to overshoot.
The current curve, however, is quite steep and tends to be consistent with a Federal Reserve that is attempting to stimulate the economy (something they also have a tendency of overshooting). Based on past readings the Cleveland Fed says the current environment is consistent with 1% growth in real GDP:
“Projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 1.0 percent rate over the next year, the same projection as in October and September. Although the time horizons do not match exactly, this comes in on the more pessimistic side of other forecasts, although, like them, it does show moderate growth for the year.”
But meager growth is better than no growth. At current levels the probability of recession is virtually 0%. Unfortunately, low growth means this is going to continue feeling like a recession for a large portion of the country. And in a balance sheet recession the usual Fed toolbox of altering interest rates is unlikely to have the usual stimulative impact.
Two observations:
1. A growth rate of even 2.5% will not be sufficient to reduce UE rates. In fact real rates of UE will likely creep up slowly next year. Federal make-work projects will result.
2. It is not unreasonable to think some of the bond market’s recent push on LT rates is in response to not only sharp recent increases in the Federal deficit but also decreased confidence in the ability of the US to actually repay in REAL dollars.
After all – none of the underlying structural problems with the US (from financial regulations to education to the rapid attrition of the middle class) have been addressed.
“Over the years the curve has successfully predicted all but two post WW2 recessions. In the last 40 years it is 7 for 7 in predicting recessions.”
also, as stated in Annaly’s recent blog entry: the bond market has predicted “at least 2 out of the last 0 recoveries”. I’d wager by summer we’ll call this last back-up in rates the “third of the last zero”….
I’d be happier if someone could present the analysis against 1990′s Japan or 1930′s USA. Then I might be willing to believe near 0% probability.
I think important take away is that the economy can grow (as it did in Japan in the 90′s) but we can still experience what basically feels like one rolling recession….
I buy that. Steve Keen has a great post around the change in the second derivative of credit deleveraging and it shows that low growth can return. Basically what’s going on. Deleveraging continues but at a slower pace.
The yield curve is irrelevant with short term yields at or near zero. The first chart posted above shows 3mth yield to 10yr yield spread. Anyone had a look at 10s30s yield curve slope recently? It is negatively sloped.
The yield curve is not that great an indicator. See research by Niall Ferguson; the yield curve kind of failed to forecast WW1 and WW2…that’s sort of a big mistake, wouldn’t you agree?
Typically the yield curve leads the economy. I think the current situation is a case where the economy will lead the curve.
History may be written yet that the Greater Recession had not ended when first thought. Or, perhaps, there will be a Greater Recession Part II. The real issue is not the current yield curve, but the curve following the next collapse bought about by the uncorrected weaknesses in the system. Already we are facing a possible second mortgage crisis from bank fraud in foreclosures, TBTF Big Banks, as well as mounting stress from govt. guaranteed education loan defaults, and a national debt that the politicians have no stomach for attempting to balance.
Its a depression not a recession. Just look at the numbers from shadowstats.com.
Its tough to compare to the 1930s, people were not in debt ubt up to their eyeballs back then.